U. S. SECURITIES AND EXCHANGE COMMISSION
			WASHINGTON, D.C. 20549FORM 10-Q(X)
			QUARTERLY REPORT PURSUANT TO SECTION 13
			OR 15(d) OF SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended September
			30, 2004OR(  )
			TRANSITION REPORT PURSUANT TO SECTION 13
			OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from
			__________ to __________Commission file number  0-26016PALMETTO BANCSHARES, INC.(Exact name of registrant as specified
			in its charter)South Carolina
			(State or other jurisdiction of incorporation or organization)
			
			74-2235055
			(IRS Employer Identification No.)301 Hillcrest Drive, Laurens, South
			Carolina
			(Address of principal executive offices)
			
			29360
			(Zip Code)(864) 984-4551
			(Registrant's telephone number)
			
			www.palmettobank.com
			(Registrant's web site)Indicate by check mark whether the registrant (1) has filed all
			reports required to be filed by Section 13 or 15(d) of the
			Securities Exchange Act of 1934 during the preceding 12 months (or
			for such shorter period that the registrant was required to file
			such reports), and (2) has been subject to such filing requirements
			for the past 90 days. Yes X   No __Indicate by check mark whether the registrant is an accelerated
			filer (as defined in Rule 12b-2 of the Exchange Act).  Yes X  
			No __Indicate the number of shares outstanding of each of the issuer's
			classes of common stock, as of the latest practicable date.Class
			
			Outstanding at November 4, 2004-----------------------------
			
			-------------------------------Common stock, $5.00 par value
			
			6,284,235









PALMETTO BANCSHARES, INC. 
		Table of ContentsPage No.PART I. 
		FINANCIAL INFORMATION
		3Item 1.
		Financial Statements
		3Item 2.
		Management's Discussion and Analysis of Financial Condition andResults of
		Operations
		20Item 3.
		Quantitative and Qualitative
		Disclosures about Market Risk
		53Item 4.
		Controls and Procedures
		53PART II. 
		OTHER INFORMATION
		54Item 1.
		Legal Proceedings
		54Item 2.
		Changes in Securities and Use of
		Proceeds
		54Item 3.
		Defaults Upon Senior Securities
		54Item 4.
		Submission of Matters to a Vote of
		Security Holders
		54Item 5.
		Other Information
		54Item 6.
		Exhibits and Reports on Form 8-K
		54SIGNATURES
		55


2




Item 1.   Financial Statements

PALMETTO BANCSHARES, INC.Consolidated Balance Sheets
			(in thousands, except share data)September 30,
			
			December 31,2004
			
			2003(unaudited)ASSETSCash and due from banks
			
			
			$         
			27,935
			
			32,309Federal funds sold
			
			
			976
			
			930Cash and cash equivalents
			
			28,911
			
			33,239Federal Home Loan Bank ("FHLB") stock,
			at cost
			2,725
			
			1,868Investment securities available for
			sale, at fair market value
			148,611
			
			128,930Loans held for sale
			
			
			3,560
			
			6,399Loans
			
			
			
			
			747,010
			
			693,213Less allowance for loan losses
			
			(8,170)
			
			(7,463)Loans, net
			
			
			738,840
			
			685,750Premises and equipment, net
			
			
			22,214
			
			21,724Accrued interest receivable
			
			
			4,087
			
			4,083Other assets
			
			
			
			16,851
			
			16,086Total assets
			
			
			$         
			965,799
			
			898,079LIABILITIES AND SHAREHOLDERS' EQUITYLiabilitiesDepositsNoninterest-bearing
			
			
			$         
			124,136
			
			115,982Interest-bearing
			
			
			659,109
			
			655,766Total deposits
			
			
			783,245
			
			771,748Retail repurchase agreements
			
			
			19,779
			
			13,525Commercial paper (Master notes)
			
			
			16,564
			
			16,170Federal funds purchased
			
			
			7,070
			
			18,000FHLB borrowings
			
			
			54,500
			
			-Other liabilities
			
			
			5,800
			
			6,647Total liabilities
			
			
			886,958
			
			826,090Shareholders' equityCommon stock - par value $5.00 per
			share;  authorized 10,000,000shares; issued and outstanding 6,281,185
			and 6,263,210at September 30, 2004 and December 31,
			2003, respectively.
			31,406
			
			31,316Capital surplus
			
			
			358
			
			250Retained earnings
			
			
			45,794
			
			39,454Accumulated other comprehensive income,
			net of tax
			1,283
			
			969Total shareholders' equity
			
			78,841
			
			71,989Total liabilities and shareholders'
			equity
			$         
			965,799
			
			898,079See accompanying notes to consolidated
			interim financial statements.


3




PALMETTO BANCSHARES, INC.Consolidated Statements of Income
			(in thousands, except share data)For the three months ended
			 September 30,2004
			
			2003(unaudited)Interest incomeInterest and fees on loans
			
			$      11,542
			
			11,510Interest and dividends on investment securities available for saleU.S. Treasury and U.S. Government agencies
			63
			
			179State and municipal
			
			
			649
			
			408Mortgage-backed securities
			
			656
			
			102Interest on federal funds sold
			
			7
			
			48Dividends on FHLB stock
			
			21
			
			18Total interest income
			
			12,938
			
			12,265Interest expenseInterest on deposits, including retail repurchase agreements
			2,581
			
			2,642Interest on securities sold under agreements to repurchase andreverse repurchase agreements
			
			-
			
			-Interest on federal funds purchased
			
			23
			
			7Interest on FHLB borrowings
			
			259
			
			-Interest on commercial paper (Master notes)
			30
			
			28Total interest expense
			
			2,893
			
			2,677Net interest income
			
			10,045
			
			9,588Provision for loan losses
			
			
			650
			
			900Net interest income after provision for loan losses
			9,395
			
			8,688Noninterest incomeService charges on deposit accounts
			2,164
			
			2,196Net fees for trust and brokerage services
			666
			
			671Mortgage banking income
			
			213
			
			219Investment securities gains
			
			(18)
			
			81Other
			
			
			
			
			710
			
			673Total noninterest income
			
			3,735
			
			3,840Noninterest expenseSalaries and other personnel
			
			4,617
			
			4,869Occupancy
			
			
			
			591
			
			583Furniture and equipment
			
			
			878
			
			884Postage and supplies
			
			
			301
			
			318Marketing and advertising
			
			285
			
			195Telephone
			
			
			
			189
			
			185Professional services
			
			
			238
			
			51Other
			
			
			
			
			1,401
			
			1,351Total noninterest expense
			
			8,500
			
			8,436Income before income taxes
			4,630
			
			4,092Provision for income taxes
			
			
			1,482
			
			1,235Net income
			
			$        3,148
			
			2,857Share Data:Net income - basic
			
			
			$          0.50
			
			0.46Net income - diluted
			
			
			0.49
			
			0.45Book value
			
			
			
			12.55
			
			11.25Dividends declared and paid per share
			0.14
			
			0.12Weighted average common shares outstanding - basic
			6,272,918
			
			6,273,780Weighted average common shares outstanding - diluted
			6,382,823
			
			6,370,340See accompanying notes to consolidated interim financial statements.




4




PALMETTO BANCSHARES, INC.Consolidated Statements of Income
			(in thousands, except share data)For the nine months ended 
			September 30,2004
			
			2003(unaudited)Interest incomeInterest and fees on loans
			
			$      34,045
			
			34,682Interest and dividends on investment securities available for saleU.S. Treasury and U.S. Government agencies
			223
			
			893State and municipal
			
			
			1,729
			
			1,182Mortgage-backed securities
			
			1,385
			
			492Interest on federal funds sold
			
			36
			
			111Dividends on FHLB stock
			
			60
			
			60Total interest income
			
			37,478
			
			37,420Interest expenseInterest on deposits, including retail repurchase agreements
			7,474
			
			8,134Interest on securities sold under agreements to repurchase andreverse repurchase agreements
			
			32
			
			-Interest on federal funds purchased
			
			54
			
			19Interest on FHLB borrowings
			
			304
			
			-Interest on commercial paper (Master notes)
			75
			
			80Total interest expense
			
			7,939
			
			8,233Net interest income
			
			29,539
			
			29,187Provision for loan losses
			
			
			2,150
			
			2,700Net interest income after provision for loan losses
			27,389
			
			26,487Noninterest incomeService charges on deposit accounts
			6,444
			
			6,417Net fees for trust and brokerage services
			2,104
			
			1,941Mortgage banking income
			
			539
			
			305Investment securities gains
			
			90
			
			362Other
			
			
			
			
			2,131
			
			1,997Total noninterest income
			
			11,308
			
			11,022Noninterest expenseSalaries and other personnel
			
			14,302
			
			14,349Occupancy
			
			
			
			1,780
			
			1,691Furniture and equipment
			
			
			2,616
			
			2,536Postage and supplies
			
			
			895
			
			1,123Marketing and advertising
			
			871
			
			632Telephone
			
			
			
			558
			
			557Professional services
			
			
			650
			
			335Other
			
			
			
			
			3,828
			
			3,898Total noninterest expense
			
			25,500
			
			25,121Income before income taxes
			13,197
			
			12,388Provision for income taxes
			
			
			4,223
			
			3,921Net income
			
			$        8,974
			
			8,467Share Data:Net income - basic
			
			
			$          1.43
			
			1.34Net income - diluted
			
			
			1.41
			
			1.32Book value
			
			
			
			12.55
			
			11.25Dividends declared and paid per share
			0.42
			
			0.36Weighted average common shares outstanding - basic
			6,267,991
			
			6,315,334Weighted average common shares outstanding - diluted
			6,378,884
			
			6,410,952See accompanying notes to consolidated interim financial statements.


5




PALMETTO BANCSHARES, INC.Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income(in thousands, except share data) (unaudited)AccumulatedShares of
			
			
			
			othercommon
			Common
			Capital
			Retained
			comprehensivestock
			stock
			surplus
			earnings
			income, net
			TotalBalance at December 31, 2002
			6,324,659
			$   31,623
			50
			34,173
			1,675
			67,521Net income
			
			
			
			
			8,467
			
			8,467Other comprehensive income, net of tax:Net unrealized holding gains (losses) arising during period, netof tax effect of $340
			
			
			
			
			
			(542)Less:  reclassification adjustment for gains includedin net income, net of tax effect of $140
			
			
			
			
			(223)Net unrealized gains on securities
			
			
			
			
			
			(765)Comprehensive income
			
			
			
			
			
			
			7,702Cash dividend declared and paid ($0.36 per share)
			
			
			
			(2,273)
			
			(2,273)Stock option activity
			
			31,965
			160
			194
			
			
			354Stock purchase
			
			(100,000)
			(500)
			
			(2,400)
			
			(2,900)Balance at September 30, 2003
			6,256,624
			$   31,283
			244
			37,967
			910
			70,404Balance at December 31, 2003
			6,263,210
			$   31,316
			250
			39,454
			969
			71,989Net income
			
			
			
			
			8,974
			
			8,974Other comprehensive income, net of tax:Net unrealized holding gains (losses) arising during period, netof tax effect of $231
			
			
			
			
			
			369Less:  reclassification adjustment for gains includedin net income, net of tax effect of $35
			
			
			
			
			(55)Net unrealized losses on securities
			
			
			
			
			
			314Comprehensive income
			
			
			
			
			
			
			9,288Cash dividend declared and paid ($0.42 per share)
			
			
			
			(2,634)
			
			(2,634)Stock option activity
			
			17,975
			90
			108
			
			
			198Balance at September 30, 2004
			6,281,185
			$   31,406
			358
			45,794
			1,283
			78,841


See accompanying notes to consolidated interim financial statements.

6




PALMETTO BANCSHARES, INC.Consolidated Statements of Cash Flows(in thousands)For the nine months ended September 30,2004
			
			2003(unaudited)Cash flows from operating activitiesNet income
			
			
			$       8,974
			
			8,467Adjustments to reconcile net income to net cashprovided by (used in) operating activitiesDepreciation and amortization
			2,985
			
			4,134Gain on sale of investment securities
			(90)
			
			(362)Provision for loan losses
			2,150
			
			2,700Origination of loans held for sale
			(28,259)
			
			(113,755)Proceeds from sale of loans held for sale
			31,637
			
			117,548Gain on sale of loans
			(539)
			
			(305)Change in accrued interest receivable
			(4)
			
			266Change in other assets
			118
			
			(1,304)Change in other liabilities, net
			(1,043)
			
			436Net cash provided by operating activities
			15,929
			
			17,825Cash flows from investing activitiesPurchase of investment securities available for sale
			(65,252)
			
			(67,353)Proceeds from maturities of investment securities available for sale
			6,787
			
			13,078Proceeds from sale and calls of investment securities available for sale
			19,387
			
			32,144Principal paydowns on mortgage-backed securities available for sale
			19,113
			
			24,693Purchase of Federal Home Loan Bank stock
			(857)
			
			(135)Net increase in loans outstanding
			(56,821)
			
			(47,846)Purchases of premises and equipment, net
			(1,893)
			
			(2,980)Net cash used in investing activities
			(79,536)
			
			(48,399)Cash flows from financing activitiesNet increase in deposit accounts
			11,497
			
			45,490Net increase in securities sold under agreements to repurchase
			6,254
			
			2,542Net increase in commercial paper
			394
			
			6,911Net decrease in federal funds purchased
			(10,930)
			
			-Net increase in FHLB borrowings
			54,500
			
			-Proceeds from stock option activity
			198
			
			354Stock purchase
			
			-
			
			(2,900)Dividends paid
			
			(2,634)
			
			(2,273)Net cash provided by financing activities
			59,279
			
			50,124Net decrease in cash and cash equivalents
			(4,328)
			
			19,550Cash and cash equivalents at beginning of period
			33,239
			
			38,093Cash and cash equivalents at end of period
			$     28,911
			
			57,643Supplemental InformationCash paid during the period for:Interest expense
			
			$       7,995
			
			8,308Income taxes
			
			
			3,292
			
			3,637Supplemental schedule of non-cash investing and financing transactionsChange in unrealized gain on investment securities availablefor sale, pre-tax
			$          510
			
			(1,245)Loans transferred to other real estate owned
			1,581
			
			677Loans charged-off
			
			1,046
			
			1,995See accompanying notes to consolidated interim financial statements.


7




PALMETTO BANCSHARES, INC.
AND SUBSIDIARY
Notes To Interim Consolidated
Financial Statements (unaudited)

Palmetto Bancshares, Inc. is a regional financial services company with
assets totaling approximately $966 million and is the holding company for The Palmetto
Bank (the "Bank").  The Bank is a full-service bank and trust company and
engages in the general banking business through 30 retail branch offices in the
Upstate South Carolina markets of Laurens, Greenville, Spartanburg, Greenwood,
Anderson, Cherokee, Abbeville, and Oconee counties (the "Upstate"). The Bank
also engages in investment services through its wholly-owned subsidiary,
Palmetto Capital, Inc. ("Palmetto Capital"). Throughout these Notes, the "Company" shall refer to
Palmetto Bancshares, Inc. and its subsidiary, the Bank.

The industry in which the Bank
operates exists primarily to provide an intermediary service to the general
public with funds to deposit and, by using these funds, to originate loans in
the markets served. The Bank provides a full range of banking activities,
including, but not limited to, checking, savings, money market, and other time
deposits for a wide range of consumer and commercial depositors, loans for
business, real estate, and personal uses, safe deposit box rental, electronic
funds transfer services, telephone banking, and bank card services. The Bank's
indirect lending department establishes relationships with Upstate automobile
dealers to provide customer financing on qualifying automobile purchases, and
its mortgage banking operation meets a range of customers' financial service
needs by originating, selling, and servicing mortgage loans. The Bank also
offers both individual and commercial trust services through an active trust
department. Palmetto Capital offers customers stocks, treasury and municipal
bonds, mutual funds, and insurance annuities, as well as college and retirement
planning.

Palmetto Bancshares is headquartered in Laurens, South Carolina and was
organized in 1982 under the laws of South Carolina. The Bank was organized and
chartered under South Carolina law in 1906.

1.  SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES

The accompanying consolidated financial statements include the accounts
of the Company.  In
management's opinion, all significant intercompany accounts and transactions
have been eliminated, and all adjustments necessary for a fair presentation of
the results for periods presented have been included.  Any such adjustments are
of a normal and recurring nature. Assets held in a fiduciary or agency
capacity for customers are not included in the consolidated financial
statements, as such assets do not represent assets of the Company. The Company primarily operates
through its wholly-owned subsidiary bank, the Bank, which represents its only
reportable segment.

The accounting and reporting policies of the Company conform to
accounting principles generally accepted in the United States of America and to
general practices within the banking industry. In preparing the consolidated
financial statements included hereto, which are unaudited with the exception of
those as of the year ended December 31, 2003, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of the date
of the consolidated financial statements for the periods presented. Actual
results could differ from these estimates and assumptions. As such, the results of operations
for the three and nine month periods ended September 30, 2004 are not
necessarily indicative of the results of operations that may be expected in
future periods.

8




The consolidated
financial statements and related notes included hereto are prepared in conformity with the
Securities and Exchange Commission's instructions for Quarterly Reports on Form
10-Q. Accordingly, certain information and footnotes required by generally
accepted accounting principles ("GAAP") for complete financial statements are
not included.  As such, the information contained in this report should be read
in conjunction with the financial statements and footnotes thereto included in
the Company's Annual Report on Form 10-K for the year ended December 31, 2003.

Certain amounts previously presented
in the consolidated financial statements for prior periods have been
reclassified to conform to current classifications. All such reclassifications
had no effect on the prior period net income or retained earnings as previously
reported.

Accounting
policies followed by the Company for reporting within this quarterly report are
consistent with the accounting policies followed for annual financial reporting
as described in Note 1 of Notes to Consolidated Financial Statementsincluded
in the Company's Annual Report on Form 10-K for the year ended December 31,
2003. With the exception of the Company's policy regarding Federal Home Loan
Bank ("FHLB") borrowings, these polices have not materially changed from the
year ended December 31, 2003.

During the
second quarter of 2004, the Company began to utilize short term and long term
borrowings from the FHLB.  FHLB borrowings are a source of funding which the
Company utilizes depending on the current level of deposits, management's
willingness to raise deposits through market promotions, the Company's unused
FHLB borrowing capacity, and the availability of collateral to secure FHLB
borrowings. Such borrowings are used to fund increases in interest earning
assets in times of declines in alternative funding sources. Short term
borrowings typically represent overnight funds sweeps used to fully utilize the Company's supply of excess
lendable funds with maturities of one year or less when made. Access to
alternate short-term funding sources allows the Company to meet funding needs
without relying on increasing deposits on a short-term basis. Long term borrowings have maturities
greater than one year when made. FHLB borrowings are collateralized by
a blanket lien on certain qualifying commercial and single-family loans held in
the Company's loan portfolio. The Company may, at its discretion, collateralize
such borrowings with securities from the Company's investment portfolio. FHLB
borrowings are an alternative to other funding sources with similar maturities.

During the
three month and nine month periods ended September 30, 2004, increases in FHLB
borrowings were used to support earning asset growth including increases in
investment securities. The following table reports information regarding the Company's long term FHLB
borrowing portfolio at September 30, 2004 (dollars in thousands).

Borrowing balance outstanding at September 30, 2004
   $  7,000
   
   
   $13,000
   
   10,000Interest rate
   2.32%
   
   
   3.27
   
   3.85Maturity date
   6/14/05
   
   
   6/14/06
   
   6/14/07


2.      
INVESTMENT
SECURITIES AVAILABLE FOR SALE

The following tables summarize the
amortized cost, gross unrealized gains, gross unrealized losses, and fair
values of investment securities available for sale at the dates indicated (in
thousands).

9




September 30, 2004Unrealized
   
   UnrealizedAmortized cost
   
   gains
   
   losses
   
   Fair valueU.S. Treasury and U.S.Government agencies
   $
   10,073
   
   52
   
   (5)
   
   10,120State and municipal
   
   68,700
   
   1,887
   
   (254)
   
   70,333Mortgage-backed securities
   
   67,751
   
   433
   
   (26)
   
   68,158Total
   $
   146,524
   
   2,372
   
   (285)
   
   148,611December 31, 2003Unrealized
   
   UnrealizedAmortized cost
   
   gains
   
   losses
   
   Fair valueU.S. Treasury and U.S.Government agencies
   $
   25,115
   
   196
   
   -
   
   25,311State and municipal
   
   53,813
   
   1,689
   
   (181)
   
   55,321Mortgage-backed securities
   
   48,425
   
   57
   
   (184)
   
   48,298Total
   $
   127,353
   
   1,942
   
   (365)
   
   128,930


Securities with an
aggregate carrying value of $72.0 million at September 30, 2004 were pledged to secure public deposits.
Investment securities available for sale were impacted by purchases, proceeds
from the sale, maturity, and / or call of such maturities as well as principal paydowns of mortgage-backed securities, which is reflected in the Consolidated
Statement of Cash Flows.

During the three months ended
September 30, 2004, the Company had no realized gains and realized losses of
$18 thousand on the sales of investment securities available for sale.  During
the same quarter of 2003, the Company had realized gains of $81 thousand and no
realized losses on sales of investment securities available for sale. During
the nine months ended September 30, 2004, the Company had realized gains of
$141 thousand and realized losses of $51 thousand on sales of investment securities
available for sale.  During the same period of 2003, the Company had realized
gains of $362 thousand and no realized losses on sales of investment securities
available for sale.  Specific identification is the basis on which cost was
determined in computing realized gains and losses.

3.      
LOANS

The Company's primary market area is
the Upstate region of South Carolina. Management closely monitors its credit
concentrations and attempts to diversify the portfolio within its primary
market area. At September 30, 2004, except for the fact that the majority of
the loan portfolio is located in the Company's primary market area, there were
no concentrations of loans in any type of industry, type of property, or to one
borrower.

The following table illustrates loans,
including deferred fees and costs and in process accounts (excluding those
mortgage loans held for sale), by classification at September 30, 2004 and
December 31, 2003 (dollars in thousands).





10




September 30,
   
   
   
   December 31,2004
   
   
   
   2003Commercial business
   $
   87,645
   
   11.9%
   
   $
   87,950
   
   12.8%Commercial real estate
   
   462,117
   
   62.5
   
   
   420,470
   
   61.3Installment
   
   20,073
   
   2.7
   
   
   22,169
   
   3.2Installment real estate
   
   49,723
   
   6.7
   
   
   47,560
   
   7.0Indirect
   
   16,023
   
   2.2
   
   
   15,644
   
   2.3Credit line
   
   2,022
   
   0.3
   
   
   2,071
   
   0.3Prime access
   
   41,730
   
   5.6
   
   
   33,015
   
   4.8Mortgage
   
   53,083
   
   7.2
   
   
   46,155
   
   6.7Bankcards
   
   10,163
   
   1.4
   
   
   9,996
   
   1.5Business manager
   
   539
   
   0.1
   
   
   2,200
   
   0.3Other
   
   1,163
   
   0.1
   
   
   1,278
   
   0.2Gross Loans
   $
   744,281
   
   100.7%
   
   $
   688,508
   
   100.4%Allowance for loan losses
   
   (8,170)
   
   (1.1)
   
   
   (7,463)
   
   (1.1)Loans in Process
   
   1,914
   
   0.3
   
   
   3,899
   
   0.6Deferred Loans Fees and costs
   
   815
   
   0.1
   
   
   806
   
   0.1Loans, net
   $
   738,840
   
   100.0%
   
   $
   685,750
   
   100.0%




Loans included in the above table are
net of whole loans and participations sold and mortgage loans serviced for
others. Mortgage loans serviced for the benefit of others amounted to $267.3
million and $269.9 million at September 30, 2004 and December 31, 2003,
respectively. Most of these mortgage loans are serviced for the Federal Home
Loan Mortgage Corporation.

As reflected in the table above, there
were no significant fluctuations in the mix of the loan portfolio when
comparing balances at December 31, 2003 with those at September 30, 2004.  
Management has continued its emphasis on loans secured by real estate during
the third quarter of 2004 due to the reduced amount of inherent risk within
such loans compared with those secured by collateral other than real estate or
loans that are unsecured. Additionally, as was the case during the year ended
December 31, 2003, the loan portfolio has continued to experience increases in
prime access loans over the periods presented primarily resulting from the no
closing costs promotional offering for such loans.

The table set forth below illustrates
the activity impacting the allowance for loan losses ("Allowance") for the
three and nine month periods ended September 30, 2004 and 2003 (in thousands).

For the three months ended
   
   For the nine months endedSeptember 30,
   
   September 30,2004
   
   2003
   
   2004
   
   2003Balance, beginning of period
   $
   7,983
   
   7,022
   
   7,463
   
   6,402Provision for loan losses
   
   650
   
   900
   
   2,150
   
   2,700Charged off loans
   
   511
   
   733
   
   1,557
   
   1,995Loan Recoveries
   
   48
   
   52
   
   114
   
   134Net charged off loans
   
   463
   
   681
   
   1,443
   
   1,861Balance, end of period
   $
   8,170
   
   7,241
   
   8,170
   
   7,241




The Allowance was $8.2 million or
1.09% of loans, excluding mortgage loans held for sale, at September 30, 2004
compared with $7.5 million or 1.08% of loans at December 31, 2003. Although
improved asset quality trends impacted the historical loss factors used in the Allowance
model contributing to the decline in provision for loan losses of 27.8% for the
three months ended September 30, 2004 over the same quarter of 2003, net
charged-off loans over the same period declined 32.0%.  Likewise, the provision
for loan losses declined 20.4% for the nine months ended September 30, 2004
over the period of 2003, while net charged-off loans over the same period
declined 22.5%.  As a result, the Allowance as a percentage of loans, excluding
mortgage loans held for sale, increased for both the three and nine month
periods ended September 30, 2004 over the respective periods of 2003.

11




The following table summarizes the
Company's nonperforming assets and loans 90 days or more past due and still
accruing interest as of the dates indicated (in thousands).

September 30,
   
   December 31,2004
   
   2003Nonaccrual loans
   $
   3,456
   
   3,828Other real estate owned
   
   2,085
   
   2,170Repossessed automobiles
   
   276
   
   243Total nonperforming assets
   
   5,817
   
   6,241Loans past due 90 days and stillaccruing (1)
   
   101
   
   212Total nonperforming assets andloans past due 90 days and stillaccruing
   $
   5,918
   
   6,453


(1) Substantially all of these loans are credit
card loans

4.      
MORTGAGE
SERVICING RIGHTS

On a quarterly basis, a third party is
utilized to determine the value of mortgage servicing rights ("MSRs") as well
as the related amortization and impairment of such rights. The external
valuation utilizes estimates for the amount and timing of mortgage loan
repayments, estimated prepayment rates, credit loss experience, costs to
service loans, and discount rates to determine an estimate of the fair value of
mortgage servicing rights. In regard to the valuation obtained at September 30,
2004, management believes that the modeling techniques and assumptions used in
conjunction with the valuation are reasonable.

In accordance with Statement of
Financial Accounting Standards ("SFAS") No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities -a
replacement of SFAS No.125," mortgage servicing assets are stratified based on
predominant risk factors in order to evaluate impairment. Impairment is
recognized and reported through a valuation allowance. Impairment is the
difference between the period end book value and the market value at the same
point in time.

Amortization expense is calculated based on current
available information regarding loan payments and prepayments. Amortization
expense could change in future periods based on changes in the volume of
prepayments and other environmental factors.

The following tables summarize the
changes in gross mortgage servicing rights during the three and nine month
periods ended September 30 (in thousands).



For the three
  months ended September 30,2004
  2003Mortgage servicing rights, beginning
  of period
  $   2,550
  2,116Capitalized mortgage servicing
  rights
  92
  516Amortization
  (159)
  (482)Total mortgage servicing rights, end
  of period
  $   2,483
  2,150


For the nine
  months ended September 30,2004
  2003Mortgage servicing rights, beginning
  of period
  $   2,607
  2,070Capitalized mortgage servicing
  rights
  355
  1,499Amortization
  (479)
  (1,419)Total mortgage servicing rights, end
  of period
  $   2,483
  2,150




12




The following tables summarize the
activity impacting the valuation allowance for impairment of mortgage servicing
rights during the three and nine month periods ended September 30 (in thousands).



For the three
  months ended September 30,2004
  2003Valuation allowance, beginning of
  period
  $   159
  246Aggregate additions charged and
  reductions credited to operations
  (7)
  --Valuation allowance, end of period
  $   152
  246


For the nine
  months ended September 30,2004
  2003Valuation allowance, beginning of
  period
  $     40
  113Aggregate additions charged and
  reductions credited to operations
  112
  133Valuation allowance, end of period
  $   152
  246


Gross mortgage servicing rights and the related valuation allowance are
included in "other assets" on the Consolidated Balance Sheets.

As management projected in its Annual
Report on Form 10-K for the year ended December 31, 2003, due to the interest
rate environment, residential mortgage production during the first nine months
of 2004 has declined compared with recent years, resulting in reduced loan
sales.  As a result, mortgage servicing rights capitalized during the first
nine months of 2004 have also declined when compared with the same period of
2003. Activity impacting the Company's mortgage servicing right portfolio,
including mortgage loans originated to be sold and sales, are reflected in the Consolidated
Statement of Cash Flows. Management expects lower origination and sales
figures to continue due
to higher mortgage loan rates. Although existing mortgage servicing rights
continued to be amortized
and evaluated for impairment, changes in current available market information
regarding such facets of the portfolio as loan payments and prepayments have
caused a decline in amortization and impairment during the nine months ended
September 30, 2004 when compared with the same period of 2003.  As noted above,
during the three and nine month periods ended September 30, 2004 amortization
of mortgage servicing rights has outpaced the capitalization of new rights.
During the same periods of 2003 the opposite was true.

5.       OTHER INTANGIBLE ASSETS

The
following table summarizes the carrying amount of other intangible assets, included in
"other assets" on the Consolidated Balance Sheets at the periods noted
(in thousands).

September 30,2004
  2003Amortized intangible assetsIntangible assets from branch
  acquisitions
  $     
  356
  501Nonamortized intangible assetsGoodwill
  $   3,691
  3,691Total other intangible assets
  $   4,047
  4,192


Intangible assets with infinite lives are subject to periodic impairment
tests in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets," on an annual basis, or more often
if events or circumstances indicate that there may be impairment. Impairment valuations as of June 30, 2004 indicated that no
impairment charge was required as of that test date, as the
carrying amount of reporting units did not exceed implied fair value. As a result, no impairment loss was
recorded.

13




The
following tables summarize the activity of intangible assets with finite lives
and the related amortization, included in "other assets" on the Consolidated
Statements of Income,
during
the three and nine month periods ended September 30 (in thousands).

For the three
  months ended September 30,2004
  2003Balance, beginning of period
  $   392
  537Amortization
  36
  36Balance, end of period
  $   356
  501


For the nine
  months ended September 30,2004
  2003Balance, beginning of period
  $   464
  608Amortization
  108
  107Balance, end of period
  $   356
  501


Amortization
expense related to intangible assets with finite lives is expected to total
$144 thousand for the year ended December 31, 2004.  In addition, amortization
expense related to intangibles of $144 thousand is expected to be recorded for
fiscal year 2005, $48 thousand for fiscal years 2006 and 2007, $45 thousand for
fiscal year 2008, and $33 thousand for fiscal year 2009.

6.       NET INCOME PER COMMON SHARE

Basic and
diluted earnings per share have been computed based on net income presented in
the accompanying Consolidated Statements of Income divided by the weighted average
common shares outstanding or assumed to be outstanding as summarized below:

For the three
  months ended September 30,2004
  2003Basic weighted average number of common shares outstanding
  6,272,918
  6,273,780Dilutive effect arising from potential common share
  issuances
  109,905
  96,560Diluted weighted average number of common shares
  outstanding
  6,382,823
  6,370,340


For the nine
  months ended September 30,2004
  2003Basic weighted average number of common shares outstanding
  6,267,991
  6,315,334Dilutive effect arising from potential common share
  issuances
  110,893
  95,618Diluted weighted average number of common shares
  outstanding
  6,378,884
  6,410,952


Option
shares are excluded from the calculation of diluted earnings when the exercise
price is greater than the average market price of the common shares as of that
date.  At September 30, 2004, there were no option shares that were excluded
from the calculation of diluted earnings, based on information available to
management at that time.

The Company
paid cash dividends of $0.14 per share for the quarter ended September 30, 2004
and $0.12 per share for the same quarter of 2003.  The Company paid cash
dividends of $0.42 per share for the nine months ended September 30, 2004 and
$0.36 per share for the same period of 2003.

14




7. 
EMPLOYEE BENEFIT
PLANS

Postretirement Benefits

The tables set forth below present the
components of the Company's net period benefit cost during the three and nine
month periods ended September 30 (in thousands).

For the three
  months ended September 30,2004
  2003Service cost
  $     119
  136Interest cost
  139
  152Expected return on plan assets
  (183)
  (200)Amortization of prior service cost
  2
  2Amortization of the net loss
  17
  29Net periodic benefit cost
  $       94
  119


For the nine
  months ended September 30,2004
  2003Service cost
  $     386
  408Interest cost
  441
  457Expected return on plan assets
  (580)
  (600)Amortization of prior service cost
  6
  6Amortization of the net loss
  53
  87Net periodic benefit cost
  $    306
  358


The Company disclosed in its Annual
Report on Form 10-K for the year ended December 31, 2003 that it expected to
contribute $1.3 million to its noncontributory defined benefit pension plan
during 2004. During the three and nine month periods ended September 30, 2004,
$323 thousand and $982 thousand was contributed, respectively.

Stock Based CompensationAt September 30, 2004, the Company had a stock-based
employee and director option plan, which is described more fully in Note 12 of Notes
to Consolidated Financial Statements included in its Annual Report on Form
10-K for the year ended December 31, 2003.  SFAS No. 123, "Accounting for
Stock-Based Compensation," allows a company to either adopt the fair value
method of valuation or continue using the intrinsic valuation method presented under
Accounting Principles Bulletin ("APB") Opinion 25, "Accounting for Stock Issued
to Employees," to account for stock-based compensation. The Company has elected
to continue following APB Opinion 25 and provide pro forma net income and pro
forma earnings per share disclosures for employee stock option grants as if the
fair value-based method defined in SFAS No. 123 had been applied. As such, no
stock-based employee compensation cost has been reflected in net income, as all
stock options granted under these plans had an exercise price equal to the fair
market value of the underlying common stock on the date of grant.

In December 2002, the Financial
Accounting Standards Board ("FASB") issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - an amendment of FASB
Statement No. 123." This Statement amends SFAS No. 123 to provide alternative
methods of transition for a voluntary change to the fair value-based method of
accounting for stock-based employee compensation. In addition, this Statement
amends the disclosure requirements of SFAS No. 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. The transition and disclosure provisions were
required for financial statements for fiscal periods ending after December 15,
2002. The Company adopted this standard effective December 31, 2002 and has
included the required interim disclosures herein.



15



---



The tables set forth below illustrate the impact the fair value recognition provisions of SFAS No. 123 to stock-based compensation would have had on net income and earnings per share if the Company had applied them for the three and nine month periods ended September 30 (in thousands, except share data).

For the three
  months ended September 30,2004
  2003Net
  income, as reported
  $   3,148
  2,857Deduct:
  Total stock-based employee and director 
             compensation expense determined under
	             
  fair value-based methods for all awards,
	             
  net of related tax effects
  34
  26Pro forma
  net income
  $   3,114
  2,831Earnings
  per shareBasic - as reported
  $    0.50
  0.46Basic - pro forma
  0.50
  0.45Diluted - as reported
  0.49
  0.45Diluted - pro forma
  0.49
  0.45






For the nine
  months ended September 30,2004
  2003Net
  income, as reported
  $   8,974
  8,467Deduct:
  Total stock-based employee and director
	             compensation expense determined under
	             
  fair value-based methods for all awards,
	             
  net of related tax effects
  101
  87Pro forma
  net income
  $   8,873
  8,380Earnings
  per shareBasic - as reported
  $    1.43
  1.34Basic - pro forma
  1.42
  1.33Diluted - as reported
  1.41
  1.32Diluted - pro forma
  1.39
  1.31




In accordance with its 1997 Stock
Compensation Plan, the Company granted 44,000 options during second quarter
2003 and 34,000 options during first quarter 2004. The fair value of each
option granted is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions used for
grants during 2004 and 2003, respectively: dividend yield of 2.7% and 2.6%,
expected volatility of 18% for grants during both years, average risk-free
interest rate of 4% for grants during both years, expected lives of 10 years,
and a vesting period of five years. The weighted average fair value of options
granted approximated $4.58 in 2004 and $4.38 in 2003. For purposes of the pro
forma calculation, compensation expense is recognized on a straight-line basis
over the vesting period.

In November 2003, the FASB issued a
tentative decision related to fair value accounting of stock options requiring
that all unvested options begin being expensed in 2005 financial statements,
which included guidance on how equity-based awards will be valued, expensed,
and classified. The Company anticipated at that time that the adoption of such
decisions would have an impact on its financial position or results of
operations although such impact could not be determined at that time.

16




In March 2004, the FASB formally proposed
to require companies to recognize the fair value of stock options and other
stock-based compensation to employees for 2005 reporting periods, a policy
consistent with the related international standard released and with convergence
between the two sets of standards. The question then followed regarding how
"share based payments" (to use the International Accounting Standard Board's
("IASB") term adopted by the FASB) should be valued and classified and the
related implementation difficulties. The exposure draft addressed only
accounting for share-based awards to employees, including
employee-stock-purchase-plans (ESPPs). Accounting for
employee-stock-ownership-plan transactions (ESOPs) and awards to nonemployees
were to be taken up in a later phase of the project.
Comments on the exposure draft were due by June 30, 2004.

On July 20, 2004, the House
passed a bill that would prevent the Securities and Exchange Commission from
putting into effect the FASB proposal to require companies to expense employee
stock options. The legislation proposed requiring public companies to report
only employee stock options granted to their CEOs and four highest-paid
officers. Small businesses would be exempted from expensing options, and new
public companies would be able to delay expensing for top executives during
their first three years. The House also approved an amendment to the
legislation to clarify that companies wishing to expense stock options
voluntarily may continue to do so. At the time, a similar bill was in the
Senate under consideration.

On October 16, 2004, the FASB voted to delay for six
months the effective date by which companies would be required to expense stock
options. The new FASB rule will require all stock options granted, modified or
settled after June 15, 2005 to be expensed in income, effective for periods
beginning after June 15, 2005. The previous effective date was January 1, 2005.
The FASB plans to issue a final rule by December 31, 2004 and will require that
companies begin disclosing in their financial statements the expected impact of
adoption of this rule for December 31, 2004 financial statements. The Company
anticipates that the adoption of such decisions would have an impact on its
financial position or results of operations beginning in 2005.

Due to the continually evolving nature
of stock option and other stock-based compensation accounting,
the Company will stay abreast of the issue and comply with any requirements
that become applicable to it.

8.      
BUSINESS SEGMENTS

The Company
has one principal operating subsidiary, The Palmetto Bank, which is evaluated
regularly by the chief operating decision makers in deciding how to allocate
resources and assess performance. This subsidiary, by virtue of exceeding certain
quantitative thresholds, is the Company's only reportable segment. The
reportable segment also provides demand transaction accounts and time deposit
accounts to businesses and individuals. The Bank offers products and services
primarily to customers in South Carolina. Revenues for the Bank are derived
primarily from interest and fees on loans, interest on investment securities,
service charges on deposits, and other customer service fees. No single
customer accounts for a significant amount of the revenues of the reportable
segment.

9.      
COMMITMENTS,
CONTINGENCIES, AND OFF-BALANCE SHEET RISK

Lending Commitments and Off-Balance
Sheet RiskIn the normal course of business, the
Company engages in a variety of financial transactions that, in accordance with
generally accepted accounting principles, are not recorded in the financial
statements or are recorded in amounts that differ from the notional amounts.
These transactions involve elements of credit, interest rate, and liquidity
risk. Such transactions are used for general corporate purposes or to meet
customer needs. Corporate purpose transactions are those used to manage
customers' requests for funding.

Off-balance sheet arrangements, which principally include commitments to
extend credit, are described below. At September 30, 2004, the Company had no
interests in non-consolidated special purpose entities nor is it involved in other off-balance
sheet contractual relationships (other than those discussed herein),
unconsolidated related entities that have off-balance sheet arrangements, or
transactions that could result in liquidity needs.

17




The Company makes contractual
commitments to extend credit, which are legally binding agreements to lend
money to customers at predetermined interest rates for a specific period of
time. The Company also provides standby letters of credit. These lending
commitments are provided to customers in the normal course of business and the
Company's credit policies and standards are applied when making these
commitments.

For commercial customers, loan
commitments generally take the form of revolving credit arrangements to finance
customers' working capital requirements. For retail customers, loan commitments
are generally lines of credit secured by residential property. Unused credit
card lines are generally used for short-term borrowings.

Generally, unused loan commitments are
at adjustable rates that fluctuate with the prime rate or are at fixed rates
that approximate market rates.

The following table summarizes issued
commitments to extend credit loan commitments and unused credit card lines at
September 30, 2004 (in thousands).

Home equity loans
  $  38,097Credit cards
  40,033Commercial real estate development
  52,684Other unused lines of credit
  36,150Total unused commitment and unused
  credit card lines
  $  166,964Standby letters of credit
  $  1,558


Outstanding commitments on mortgage
loans not yet closed, the majority of which include interest rate lock
commitments, amounted to approximately $3.7 million at September 30, 2004.
These were principally single-family loan commitments. Commitments to extend
credit are agreements to lend to borrowers as long as there is no violation of
any condition established by the commitment letter. Commitments generally have
fixed expiration dates or other termination clauses. The majority of the
commitments will be funded within a 12-month period. Each customer's
creditworthiness is evaluated on a case-by-case basis. The amount of collateral
obtained, if deemed necessary upon extension of credit, is based on
management's credit evaluation of the borrower. Collateral held consists of
residential properties.

Standby letters of credit represent an
obligation to a third party contingent upon the failure of a customer to
perform under the terms of an underlying contract with the third party, or
obligates the Company to guarantee or stand as surety for the benefit of the
third party. The underlying contract may entail either financial or
nonfinancial obligations and may involve such things as the customer's delivery
of merchandise, completion of a construction contract, release of a lien, or
repayment of an obligation. Under the terms of a standby letter of credit,
generally, drafts will be drawn only when the underlying event fails to occur as
intended. The Company can seek recovery of the amounts paid from the borrower.
However, standby letters of credit are generally not collateralized. In recent
months the Company has reflected in its policy regarding such commitments that
collateral is encouraged with exceptions requiring approvals. Commitments under
standby letters of credit are usually for one year or less. At September 30,
2004, the Company has recorded no liability for the current carrying amount of
the obligation to perform as a guarantor and no contingent liability is
considered necessary, as the Company believes the likelihood that it will have
to perform under such contracts is not likely. The maximum potential amount of
undiscounted future payments related to standby letters of credit at September
30, 2004 was $1.6 million. Past experience indicates that many of these standby
letters of credit will expire unused. However, through its various sources of
liquidity, the Company believes that it has the necessary resources to meet these
obligations should the need arise. Additionally, current fair values of such
guarantees are deemed immaterial at September 30, 2004.

18




The Company originates, sells, and
services mortgage loans. All of the loan sales within the first nine months of
2004 were without provision for recourse. Mortgage loans serviced for the
benefit of others, which are not owned by the Company and therefore are not
recorded on the Consolidated Balance Sheets, amounted to $267.3 million
and $269.9 million at September 30, 2004 and December 31, 2003, respectively.

ContingenciesThe Company is currently the defendant in
certain legal proceedings and claims that have arisen in the ordinary course of
its business. In the opinion of management based on consultation with external
legal counsel, any reasonably foreseeable outcome of such current litigation
would not materially affect the Company's consolidated financial position or
results of operations.

On May 18, 2004, Glen
Meadows, LLC, WACC, LLC, and BC Ventures, LLC filed a complaint against The
Palmetto Bank and two other financial institutions claiming that a dishonest
employee (of the plaintiffs) deposited checks drawn on company accounts at the
latter two institutions and deposited these funds into the employee's account at
The Palmetto Bank. Although The Palmetto Bank contended that we had no
obligation to the drawer of the checks due to the extended period of time
between the occurrences and the claim, the compliant was settled during the
third quarter of 2004 for $75,000.

Lease AgreementsThe Company has not entered into any material property and
equipment leases during the nine month period ended September 30, 2004.

10.  
RELATED PARTY
TRANSACTIONS

In the ordinary course of business,
the company engages in business transactions with certain of its directors and
employees. Such transactions are competitively negotiated at arms-length by the
Company and are not considered to include terms that are unfavorable to the
Company.

19






Item 2. 
Management's Discussion and Analysis of Financial Condition and Results of
Operations

WEBSITE
AVAILABILITY OF REPORTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION

The Bank's
website, www.palmettobank.com, includes a link to the Securities and Exchange
Commission's Electronic Data Gathering, Analysis, and Retrieval ("EDGAR")
system which makes various reports filed with the Securities and Exchange
Commission by the Company, including, but not limited to, its Annual Report on
Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K,
Ownership Reports filed in conjunction with Section 16, and amendments to such
reports, available, free of charge.  These reports are made available as soon
as reasonably practicable after these reports are filed with, or furnished to,
the Securities and Exchange Commission.  The Securities and Exchange
Commission's EDGAR database may also be accessed through its website,
www.sec.gov.

FORWARD-LOOKING
STATEMENTS

In this report and in other reports
and proxy statements filed with the Securities and Exchange Commission (the
"SEC"), forward-looking statements (as defined in the Private Securities Litigation Reform Act
of 1995) are made. In addition, management may make forward-looking
statements orally. Broadly speaking, forward-looking statements include, but
are not limited to, projections of the revenues, income, earnings per share,
capital expenditures, dividends, capital structure, or other financial items,
descriptions of plans or objectives for future operations, products or
services, forecasts of future economic performance, and descriptions of
assumptions underlying or relating to any of the foregoing.

Forward-looking statements discuss
matters that are not historical facts. Because they discuss future events or
conditions, forward-looking statements often include words such as
"anticipate," "believe," "estimate," "expect," "intend," "plan," "project,"
"target," "can," "could," "may," "should," "will," "would," or similar
expressions. Do not unduly rely on forward-looking statements. Such statements
give management's expectations about the Company's future and are not guarantees.
Forward-looking statements speak only as of the date they are made, and no obligation is undertaken to
update any forward-looking statement to reflect events or circumstances after
the date on which such statement is made to reflect the occurrence of unanticipated
events. In addition, certain statements included in future filings of the
Company with the SEC, in press releases, and/or in oral and written statements
made by or with the approval of the Company, which are not statements of
historical fact, constitute forward-looking statements.

There are several factors, many beyond
the Company's and its management's control, that could cause results to differ
from expectations. Some of these factors include, but are not limited to,

- changes in economic and / or
     industry conditions and monetary policy;
- changes in interest rates,
     deposit rates, the net interest margin, and / or funding sources;
- market risk and inflation;
- risks inherent in making loans
     including repayment and collateral risk;
- volume of loan growth;
- the adequacy of the allowance for
     loan losses (the "Allowance") and the assessment of problem loans;
- the ability of the Company to
     meet its contractual obligations;
- fluctuations in consumer
     spending;
- competition in the banking
     industry and the related demand for banking products and services;
- dependence on senior management;
- technological changes;

20






- the ability to maintain and / or
     increase market share;
- the reliability of expense
     projections;
- risks associated with income
     taxes, including the potential for adverse adjustments;
- changes in accounting policies
     and practices;
- potential cost and impact of
     litigation; and
- the impact of recently-enacted or proposed legislation.

Many of these factors, as well as
other factors, such as credit, market, operational, liquidity, interest rate,
and other risks, are discussed in more detail in the Company's Annual Report on
Form 10-K for the year ended December 31, 2003. Any factor described in this
Quarterly Report on Form 10-Q or in that Annual Report on Form 10-K could by
itself, or together with one or more factors, adversely affect the business,
financial condition, and / or results of operations of the Company.
Additionally, there are factors that may not be described in this report that
could cause actual results to differ from expectations.

COMPANY OVERVIEW

Palmetto Bancshares is a bank holding
company organized under the laws of South Carolina in 1982. The Palmetto Bank
(the "Bank"), a wholly-owned subsidiary of Palmetto Bancshares, was organized
and chartered under South Carolina law in 1906.  The Company's corporate
offices are located at 301 Hillcrest Drive, Laurens, South Carolina. The Bank
is a full-service bank and trust company.  At September 30, 2004, the Bank had
thirty full-service branches in the Upstate region of South Carolina within the
following counties: Laurens County (4), Greenville County (10), Spartanburg
County (5), Greenwood County (5), Anderson County (3), Cherokee County (2), and
Oconee County (1).  In addition to branch locations, at September 30, 2004, the
Bank has 27 automatic teller machine ("ATM") locations (including two at
non-branch locations) and five limited service branches located in retirement
centers in the Upstate. The Company added a new ATM to its Simpsonville market
in October 2004. The Bank engages in investment services through its
wholly-owned subsidiary, Palmetto Capital, Inc. ("Palmetto Capital").
Throughout this report, the "Company" shall refer to Palmetto Bancshares, Inc. and its
subsidiary.

The Company's primary market area is
located within South Carolina in the foothills region of Greenville, including Greenville County
and its surrounding counties. Primary business sectors in the region include
banking and finance, manufacturing, health care, retail, telecommunications,
government services, and education. The Company believes that it is not
dependent on any one or a few types of commerce due to the area's diverse
economic base.

The Upstate is a designated foreign trade zone area,
and boasts the highest level of foreign capital investment per capita in the
nation, and is home to more than 240 international firms from 23 nations,
including BMW, Hitachi, and Michelin. While commercial real estate lending has
not returned to the levels seen before the economic downturn of recent years,
activity in this sector has increased. Having recently annexed more than 724
acres of prime development property, the Upstate is believed to be the cutting
edge of new industrial opportunities. Along with the creation of the Millennium
Campus and an automotive research park at the site, part of a joint venture
with Clemson University and BMW, developers are ready to bring many new
industries to the area.

21




No new branches were opened during the twelve month period
ended September 30, 2004, although management continually reviews opportunities
for Upstate expansion that it believes to be in the best interest of the
Company, its customers, and its shareholders. Expansion opportunities are
currently being evaluated in the market areas in which the Company currently
serves. During the second quarter of 2004, the Company closed on a real estate
site in Easley, South Carolina that will introduce the Company's presence into
Pickens County. Easley
is a culturally diverse community with approximately 20,000 residents living
within the city limits. Maintaining
the Company's focus on serving Upstate South Carolina, ground will be broken on
the new office in Easley in December 2004, with the branch opening scheduled
for third quarter 2005.

In addition to traditional banking
services, the Company's offers brokerage and trust services. Community banking
includes the retail and commercial distribution network consisting of 30
branches, telephone banking, and internet banking. Community banking provides a
variety of depository accounts including interest-bearing and
noninterest-bearing checking accounts, savings accounts, certificates of
deposit and money market accounts. In addition, community banking offers a
variety of loan products, including commercial, consumer, real estate and home
equity loans as well as credit card services. The Bank also maintains 27 ATMs
and allows customers to access their accounts on-line. The mortgage business
provides both fixed-rate and variable-rate mortgage products and loan
servicing. Mortgage lenders are located in the community bank branches.
Palmetto Capital offers full service and discount brokerage, annuity sales and
financial planning services through a third party arrangement with Raymond
James. The Company also offers trust services for companies and individuals.
Investment advisors are based in branch locations in community bank branches. 
In addition, separate investment facilities are maintained in Greenville and
Laurens Counties.  Trust professionals are located in the community bank
branches as well as in the Company's operations center.

The Company derives interest income
through traditional banking activities such as generating loans and earning
interest on securities. Income is also earned from fees on deposit accounts and
mortgage, brokerage, and trust services. Also, as a part of the Company's
management of its securities portfolio, income is recognized on the sale of
securities. Improving the net interest margin is critical to the Company's
strategy to grow earnings. However, the recent interest rate environment has
continued to pressure loan yields. Although the lending environment continues
to be challenging due to economic conditions, loan growth continues to be a
primary focus for the Company.

Lowering
funding costs is essential to improving the Company's net interest margin. The
Company continues its focus on growing deposits balances while remaining
cognizant of pricing dilemmas resulting from
the recent interest rate environment. In addition to traditional funding
sources, during 2004,
the Company began to utilize Federal Home Loan Bank ("FHLB") borrowings to
support earning asset growth, including increases in investment securities.
Although often obtained at rates higher than those obtained through traditional
funding sources, borrowings represent a source of funding diversification,
which can be used for leverage in deposit pricing. In addition, they help an
institution avoid overpaying for deposits. Among other tools, the Company uses
marginal cost analyses when considering funding options.  Management believes
that marginal cost analysis is the key to incorporating borrowings in deposit
pricing. Although alternative funding sources, such as FHLB borrowings, do not
always result in lower interest expense, management believes that such funding
alternatives can increase net interest income by employing these funds in higher yield assets.

Since asset quality is tied to
profitability and capital adequacy, maintaining sound asset quality
continues to be a primary focus for the Company. As a result of this focus and
the initiatives taken during recent years, our asset quality ratios have
improved significantly and remain strong as of and for the periods ended
September 30, 2004. Activities designed to monitor and improve asset quality
typically have a positive impact on earnings by reducing the credit risk
profile of the Company and reducing future collection costs. Nevertheless,
certain risks are inherent within any loan portfolio particularly portfolios
containing commercial, commercial real estate, and consumer loans, which must
be continually managed. Management monitors asset quality and credit risk on an
ongoing basis.

22




The Company is focused on retaining
existing customers and attracting new customers. The Company feels that it sets
itself apart from its competitors by providing superior personal service. This
is accomplished through a variety of delivery channels marketing a full range
of high quality financial products and services. The Company sets strategic
targets for net growth in deposit accounts annually in an effort to cross-sell,
thereby increasing the products per banking relationship. Traditional marketing
techniques are employed to attract new customers including, but not limited to,
direct mailings and advertising, as the Company recognizes that attracting new
customers provides, in addition to interest opportunities, a new avenue for the
generation of fee income.  In addition, new deposit customers are key to
providing a mix of lower-cost funding sources. To meet the convenience needs of
existing and potential customers, the Company offers early bird hours at select
branch locations, Saturday banking at select branch locations, a telephone
banking call center, as well as Internet banking options. The Company will
continue to expand into new areas as both market and economic conditions
warrant.

Consistent with the United
States banking industry's increased reliance on nontraditional business
activities to generate fee income, trading revenue, and other types of
noninterest income, the Company continues to place emphasis on noninterest
income for possible growth opportunities. These sources of income typically provide a boost to revenue while
being less dependent on overall business conditions than traditional interest
income. As a result of the Company's emphasis increases have been experienced
related to service charges on deposit accounts, brokerage and trust services,
and mortgage banking services in the first nine months of 2004.  The Company
continuously reviews opportunities for new products, services, and expansion
opportunities as conditions warrant.

The
following discussion and analysis is presented to assist in understanding the
financial condition and results of operations of the Company.  This discussion
should be read in conjunction with the consolidated financial statements and
related notes and other financial data appearing in this report as well as in
the Company's Annual Report on Form 10-K for the year ended December 31, 2003. 
Results of operations for the three and nine month periods ended September 30,
2004 are not necessarily indicative of results that may be attained for any
other period.  Percentage calculations contained herein have been calculated
based upon actual, not rounded, results.

FINANCIAL SUMMARY

Net income totaled $3.1 million, or $0.49 per diluted share, for the
three months ended September 30, 2004, compared to net income of $2.9 million
or $0.45 per diluted share for the same period in 2003. For the nine months
ended September 30, 2004, net income amounted to $9.0 million, or $1.41 per
diluted share, compared with net income of $8.5 million or $1.32 per diluted
share for the same period in 2003. Net income for the three months and nine
months ended September 30, 2004 increased due primarily to higher net interest
income as well as a decline in the provision for loan losses.  This decline in
the provision for loan losses is primarily attributable to improved asset
quality trends that directly impact the historical loss factors used in the
Allowance model.  The increase in net interest income resulted from an increase
in volume offset by a decline in rates as well as the results of certain
asset-liability management transactions entered into during the second and
third quarters of 2004.

During the third quarter of 2004, the Company's nontraditional banking
services continued to generate strong revenue growth consistent with the third
quarter of 2003. In the aggregate, noninterest expense remained relatively unchanged
during the three months ended September 30, 2004 when compared with the same
period of 2003 primarily due to a reduction in salaries and other personnel
expense being absorbed through slight increases in marketing and professional
services expense.  Salaries
and other personnel expense, the largest component of noninterest expense,
accounted for approximately 54.3% of total noninterest expenses for the quarter
ended September 30, 2004. Income tax expense increased $247 thousand due to
an increase in projected taxable income relative to nontaxable adjustments.

23




During the first nine months of 2004,
the Company's nontraditional banking services continued to generate strong
revenue growth compared to the first nine months of 2003, with net fees for trust
and brokerage services up 8.4%, mortgage banking income up 76.7% and other
noninterest income up 6.7%. These increases were offset slightly by a 75.1%
decline in gains on investment security sales. Noninterest expense increased
1.5% primarily due to increases in marketing and professional services expense.
These increases were offset slightly by declines in postage and supplies
expense. Salaries and
other personnel expense, the largest component of noninterest expense,
accounted for approximately 56.1% and 57.1% of total noninterest expenses for
the nine months ended September 30, 2004 and 2003, respectively. Income tax
expense increased $302 thousand due to an increase in projected taxable income
relative to nontaxable adjustments.

















24



---

At and for the three months
			
			
			
			At and for the nine monthsended September 30,
			
			
			
			ended September 30,2004
			
			2003
			
			
			
			2004
			
			2003(Dollars in thousands, except share data)SUMMARY OF OPERATIONSInterest income
			$             12,938
			
			12,265
			
			
			
			37,478
			
			37,420Interest expense
			2,893
			
			2,677
			
			
			
			7,939
			
			8,233Net interest income
			10,045
			
			9,588
			
			
			
			29,539
			
			29,187Provision for loan losses
			650
			
			900
			
			
			
			2,150
			
			2,700Net interest income after provision for loan losses
			9,395
			
			8,688
			
			
			
			27,389
			
			26,487Noninterest income
			3,735
			
			3,840
			
			
			
			11,308
			
			11,022Noninterest expense
			8,500
			
			8,436
			
			
			
			25,500
			
			25,121Income before income taxes
			4,630
			
			4,092
			
			
			
			13,197
			
			12,388Provision for income taxes
			1,482
			
			1,235
			
			
			
			4,223
			
			3,921Net income
			$               3,148
			
			2,857
			
			
			
			8,974
			
			8,467SHARE DATANet income per common share:Basic
			$                 0.50
			
			0.46
			
			
			
			1.43
			
			1.34Diluted
			0.49
			
			0.45
			
			
			
			1.41
			
			1.32Cash dividends per common share
			0.14
			
			0.12
			
			
			
			0.42
			
			0.36Book value per common share
			12.55
			
			11.25
			
			
			
			12.55
			
			11.25Outstanding common shares
			6,281,185
			
			6,256,624
			
			
			
			6,281,185
			
			6,256,624Weighted average common shares outstanding - Basic
			6,272,918
			
			6,273,780
			
			
			
			6,267,991
			
			6,315,334Weighted average common shares outstanding - Diluted
			6,382,823
			
			6,370,340
			
			
			
			6,378,884
			
			6,410,952PERIOD-END BALANCESAssets
			$           965,799
			
			882,774
			
			
			
			965,799
			
			882,774Investment securities available for sale, at fair market value
			148,611
			
			110,506
			
			
			
			148,611
			
			110,506Loans held for sale
			3,560
			
			8,363
			
			
			
			3,560
			
			8,363Loans
			747,010
			
			670,850
			
			
			
			747,010
			
			670,850Allowance for loan losses
			8,170
			
			7,241
			
			
			
			8,170
			
			7,241Deposits
			819,588
			
			804,604
			
			
			
			819,588
			
			804,604Borrowings
			61,570
			
			-
			
			
			
			61,570
			
			-Shareholders' equity
			78,841
			
			70,404
			
			
			
			78,841
			
			70,404AVERAGE BALANCESAssets
			$           949,582
			
			873,008
			
			
			
			918,943
			
			851,477Earning assets
			889,366
			
			813,022
			
			
			
			857,354
			
			790,991Loans and loans held for sale
			734,155
			
			682,035
			
			
			
			719,178
			
			664,506Total deposits
			824,528
			
			789,333
			
			
			
			815,341
			
			770,253Borrowings
			42,322
			
			2,610
			
			
			
			22,694
			
			1,939Shareholders' equity
			77,040
			
			70,546
			
			
			
			75,311
			
			70,393RATIOSReturn on average assets
			1.32
			%
			1.30
			
			
			
			1.30
			
			1.33Return on average equity
			16.26
			
			16.07
			
			
			
			15.92
			
			16.08Net interest margin
			4.63
			
			4.76
			
			
			
			4.73
			
			5.03Average loans to average deposits
			89.04
			
			86.41
			
			
			
			88.21
			
			86.27Average equity to average assets
			8.11
			
			8.08
			
			
			
			8.20
			
			8.27Dividend payout ratio
			27.92
			
			26.25
			
			
			
			29.35
			
			26.85Equity to assets at year end
			8.16
			
			7.98
			
			
			
			8.16
			
			7.98SIGNIFICANT CREDIT QUALITY RATIOSNonaccrual loans to total assets
			0.36
			%
			0.59
			
			
			
			0.36
			
			0.59Net charge-offs to average loans less mortgage loansheld for sale
			0.25
			
			0.41
			
			
			
			0.27
			
			0.38




25

---





CRITICAL ACCOUNTING POLICIES

The Company's accounting and financial
reporting policies are in conformity with generally accepted accounting
principles ("GAAP") and with general practice within the banking industry. The
preparation of financial statements in conformity with such principles requires
management to make estimates and assumptions that impact the reported amounts
of assets and liabilities, the disclosure of contingent assets and liabilities
at the date of the financial statements, and the reported amounts of revenues
and expenses during the reporting period. During the annual financial reporting
process, management, in conjunction with the Company's independent auditors,
discusses the development and selection of the critical accounting estimates
with the Audit Committee of the Board of Directors.  Additionally, the Audit
Committee reviews the Company's Quarterly Reports on Form 10-Q and the Annual
Reports on Form 10-K including all related disclosures.

In order to
understand the Company's financial position and results of operations, it is
important to understand the Company's critical accounting policies and the
extent to which judgment and estimates are used in applying such policies. The Company's
significant accounting policies are discussed in Item 7 and Note 1 of Notes
to Consolidated Financial Statements of its Annual Report on Form 10-K for
the year ended December 31, 2003. Of these significant accounting policies,
policies regarding the accounting for its allowance for loan losses, pension
plan, mortgage servicing rights, and income taxes, are considered to be the
most critical accounting policies due to the valuation techniques used and the
sensitivity of these financial statement amounts to the methods, assumptions,
and estimates underlying these balances. Accounting for these critical areas
requires a significant degree of management judgment that could be subject to
revision as current information becomes available. In order to assist in the
determination of critical accounting policies, management considers whether the
accounting estimate requires assumptions about matters that were highly
uncertain at the time the accounting estimate was made and whether different
estimates that reasonably could have been used in the current period, or
changes in the accounting estimate that are reasonably likely to occur from
period to period, would have a material impact on the Company's financial
condition or results of operations.

Based on a critical assessment of its
accounting policies and the underlying judgments and uncertainties impacting
the application of these policies, management believes that the Company's
consolidated financial statements provide a meaningful and fair presentation of
its current financial condition. This is not to suggest that risk factors, some
of which are described in Forward-Looking Statements, could not adversely
impact this condition.

NON-GAAP
FINANCIAL INFORMATION

This report
contains financial information determined by methods other than in accordance
with GAAP. The Company's management uses these non-GAAP measures to analyze
performance. In particular, certain designated net interest income amounts are
presented on a tax-equivalent basis. Management believes that the presentation
of net interest income on a tax-equivalent basis aids in the comparability of
net interest income arising from both taxable and tax-exempt sources. These
disclosures should not be viewed as a substitute for GAAP measures, and
furthermore, the Company's non-GAAP measures may not necessarily be comparable
to non-GAAP performance measures of other companies.

26






EARNINGS
REVIEW

Net
Interest Income and MarginNet interest income is the difference
between gross interest and fees on interest-earning assets, primarily loans and
investment securities, and interest paid on deposits and other interest-bearing
liabilities and represents the largest component of earnings for the Company.
The net yield on interest-earning assets measures how effectively a company
manages the difference between the yield on interest-earning assets and the
rate paid on funds to support those assets. Fully tax-equivalent net interest
income is a non-GAAP performance measure used by management in operating the
business which management believes provides investors with a more accurate
picture of the interest margin for comparative purposes.  This measure adjusts
the yield for assets earning tax-exempt income to a comparable yield on a
taxable basis. Balances of interest-earning assets and successful management of
the net interest margin determine the level of net interest income. Changes in
interest rates earned and paid on assets and liabilities, the rate of growth of
the asset and liability base, the ratio of interest-earning assets to
interest-bearing liabilities, and the management of interest rate sensitivity
cause changes in net interest income.

The following tables present the
Company's analysis of net interest income on a fully tax-equivalent basis and
average balance sheets for the three and nine months ended September 30, 2004
(dollars in thousands).









27




For the three months ended September 30,2004
			
			2003Average
			Income/
			Yield/
			
			Average
			Income/
			Yield/Balance
			Expense
			Rate
			
			Balance
			Expense
			RateASSETSInterest-earnings
			assetsFederal funds sold
			$
			2,011
			$
			7
			1.38
			%
			$
			19,536
			$
			48
			0.97
			%Federal Home Loan
			Bank stock and deposits
			2,578
			21
			3.24
			
			2,183
			18
			3.27Nontaxable
			investment securities (1) (3)
			69,376
			957
			5.49
			
			39,322
			580
			5.85Taxable investment
			securities (3)
			81,246
			719
			3.52
			
			69,946
			282
			1.60Loans, net of
			unearned (2)
			734,155
			11,542
			6.25
			
			682,035
			11,510
			6.70Total
			interest-earning assets
			889,366
			13,246
			5.93
			
			813,022
			12,438
			6.07Noninterest-earning
			assetsCash and due from
			banks
			23,879
			
			
			
			27,705Allowance for loan
			losses
			(8,030)
			
			
			
			(6,990)Premises and
			equipment, net
			22,415
			
			
			
			20,227Accrued interest
			4,037
			
			
			
			3,831Other assets
			17,915
			
			
			
			15,213Total noninterest-earning
			assets
			60,216
			
			
			
			59,986Total assets
			$
			949,582
			
			
			
			$
			873,008LIABILITIES AND
			SHAREHOLDERS' EQUITYLiabilitiesInterest-bearing
			liabilitiesDemand deposits
			$
			262,432
			$
			244
			0.37
			%
			$
			248,022
			$
			244
			0.39
			%Savings
			48,240
			37
			0.31
			
			43,014
			36
			0.33Time
			
			352,479
			2,271
			2.56
			
			347,479
			2,342
			2.67Total
			interest-bearing deposits
			663,151
			2,552
			1.53
			
			638,515
			2,622
			1.63Retail repurchase
			agreements
			22,499
			29
			0.51
			
			15,509
			20
			0.51Commercial paper
			17,148
			30
			0.70
			
			18,749
			28
			0.59Federal funds
			purchased
			5,789
			23
			1.58
			
			2,610
			7
			1.06FHLB Advances
			36,533
			259
			2.82
			
			-
			-
			-Other
			interest-bearing liabilities
			-
			-
			-
			
			-
			-
			-Total
			interest-bearing liabilities
			745,120
			2,893
			1.54
			
			675,383
			2,677
			1.57Noninterest-bearing
			liabilitiesNoninterest-bearing
			deposits
			121,730
			
			
			
			116,560Other noninterest-bearing
			liabilities
			5,692
			
			
			
			10,519Total noninterest-bearing
			liabilities
			127,422
			
			
			
			127,079Total liabilities
			872,542
			
			
			
			802,462Shareholders'
			equity
			77,040
			
			
			
			70,546Total liabilities
			and shareholders' equity
			$
			949,582
			
			
			
			$
			873,008NET INTEREST MARGIN
			(FTE) (1) / NET YIELD ONINTEREST-EARNING
			ASSETS (FTE)
			
			$
			10,353
			4.63
			
			
			$
			9,761
			4.76
			%Tax-equivalent
			adjustment (1)
			
			308
			
			
			
			173NET INTEREST MARGIN
			
			$
			10,045
			
			
			
			$
			9,588NOTE - Designated
			net interest income amounts are presented on a tax-equivalent basis.
			Management believes that thepresentation of net
			interest income on a tax-equivalent basis aids in the comparability
			of net interest income arising from bothtaxable and
			tax-exempt sources. A reconciliation is included which reconciles
			non-GAAP measures with amountsthat would have
			been reported under GAAP measures.(1)
			Yields on
			nontaxable securities are stated on a fully taxable equivalent
			basis, using the applicable effective tax rate of32% and 30% for the
			three month period ended September 30, 2004 and 2003, respectively. 
			The adjustments made to convert nontaxableinvestments to a
			fully taxable equivalent basis were $308 and $173 for the 2004 and
			2003 periods, respectively.(2)
			The preceding
			analysis takes into consideration the principal amount of nonaccrual
			loans and only income actually collectedand recognized on
			such loans. All loans and deposits are domestic. Average loan
			balances are shown net of unearned income.(3)
			The average
			balances for investment securities include the unrealized gain or
			loss recorded for available for sale securities.


28




For the nine months ended September 30,2004
			
			2003Average
			Income/
			Yield/
			
			Average
			Income/
			Yield/Balance
			Expense
			Rate
			
			Balance
			Expense
			RateASSETSInterest-earnings
			assetsFederal funds sold
			$
			4,658
			$
			36
			1.03
			%
			$
			13,451
			$
			111
			1.10
			%Federal Home Loan
			Bank stock and deposits
			2,602
			60
			3.08
			
			2,153
			60
			3.73Nontaxable
			investment securities (1) (3)
			61,888
			2,543
			5.49
			
			36,894
			1,729
			6.27Taxable investment
			securities (3)
			69,028
			1,608
			3.11
			
			73,987
			1,385
			2.50Loans, net of
			unearned (2)
			719,178
			34,045
			6.32
			
			664,506
			34,682
			6.98Total
			interest-earning assets
			857,354
			38,292
			5.97
			
			790,991
			37,967
			6.42Noninterest-earning
			assetsCash and due from
			banks
			25,853
			
			
			
			27,670Allowance for loan
			losses
			(7,755)
			
			
			
			(6,968)Premises and
			equipment, net
			22,178
			
			
			
			19,965Accrued interest
			3,865
			
			
			
			4,124Other assets
			17,448
			
			
			
			15,695Total noninterest-earning
			assets
			61,589
			
			
			
			60,486Total assets
			$
			918,943
			
			
			
			$
			851,477LIABILITIES AND
			SHAREHOLDERS' EQUITYLiabilitiesInterest-bearing
			liabilitiesDemand deposits
			$
			264,131
			$
			689
			0.35
			%
			$
			245,521
			$
			855
			0.47
			%Savings
			46,640
			101
			0.29
			
			41,399
			112
			0.36Time
			
			349,367
			6,606
			2.53
			
			336,989
			7,106
			2.82Total
			interest-bearing deposits
			660,138
			7,396
			1.50
			
			623,909
			8,073
			1.73Retail repurchase
			agreements
			20,544
			78
			0.51
			
			16,247
			61
			0.50Commercial paper
			15,900
			75
			0.63
			
			17,468
			80
			0.61Federal funds
			purchased
			5,208
			54
			1.39
			
			1,939
			19
			1.31FHLBAdvances
			14,136
			304
			2.87
			
			-
			-
			-Other
			interest-bearing liabilities
			3,350
			32
			1.28
			
			-
			-
			-Total
			interest-bearing liabilities
			719,276
			7,939
			1.47
			
			659,563
			8,233
			1.67Noninterest-bearing
			liabilitiesNoninterest-bearing
			deposits
			118,759
			
			
			
			112,629Other noninterest-bearing
			liabilities
			5,597
			
			
			
			8,892Total noninterest-bearing
			liabilities
			124,356
			
			
			
			121,521Total liabilities
			843,632
			
			
			
			781,084Shareholders'
			equity
			75,311
			
			
			
			70,393Total liabilities
			and shareholders' equity
			$
			918,943
			
			
			
			$
			851,477NET INTEREST INCOME
			(FTE) (1) / NET YIELD ONINTEREST-EARNING
			ASSETS (FTE)
			
			$
			30,353
			4.73
			
			
			$
			29,734
			5.03Tax-equivalent
			adjustment (1)
			
			814
			
			
			
			547NET INTEREST MARGIN
			
			$
			29,539
			
			
			
			$
			29,187NOTE - Designated
			net interest income amounts are presented on a tax-equivalent basis.
			Management believes that thepresentation of net
			interest income on a tax-equivalent basis aids in the comparability
			of net interest income arising from bothtaxable and
			tax-exempt sources. A reconciliation is included which reconciles
			non-GAAP measures with amountsthat would have
			been reported under GAAP measures.(1)
			Yields on
			nontaxable securities are stated on a fully taxable equivalent
			basis, using the applicable effective tax rate of32% for both the
			nine month periods ended September 30, 2004 and 2003.  The
			adjustments made to convert nontaxableinvestments to a
			fully taxable equivalent basis were $814 and $547 for the 2004 and
			2003 periods, respectively.(2)
			The preceding
			analysis takes into consideration the principal amount of nonaccrual
			loans and only income actually collectedand recognized on
			such loans. All loans and deposits are domestic. Average loan
			balances are shown net of unearned income.(3)
			The average
			balances for investment securities include the unrealized gain or
			loss recorded for available for sale securities.


29




Fully tax-equivalent net interest
income for the quarter ended September 30, 2004 increased $592 thousand, or
6.1%, to $10.4 million from the quarter ended September 30, 2003. This increase
was attributed to an $808 thousand increase in fully tax-equivalent interest
income over the same period, slightly offset by an increase in interest expense
for the same period. Fully tax-equivalent net interest income for the nine
months ended September 30, 2004 increased $619 thousand, or 2.1%, to $30.4
million from the nine month period ended September 30, 2003. This increase was
due to an increase in fully tax-equivalent interest income of $325 thousand
over the period as well as a decline in interest expense over the period of
$294 thousand. As summarized in the previous tables, the increase in fully-tax
equivalent interest income during both the three and nine months ended
September 30, 2004 when compared with the same periods of 2003 results from
increases in interest-earning assets of 9.4% and 8.4%, respectively, partially
offset by lower yields on interest-earning assets during the periods resulting
from the low interest rate environment of recent years.

When comparing the three months ended
September 30, 2004 over the same period of 2003, interest expense increased
$216 thousand.  Interest expense for the nine months ended September 30, 2004
decreased by $294 thousand compared to the same period of 2003.  For the three
and nine month periods ended September 30, 2004, interest expense on deposit
accounts declined $70 thousand and $677 thousand, respectively, compared to
comparable 2003 periods.  This decline in interest expense on deposit accounts
was due in part to the downward pricing of deposit products over the periods
presented resulting from the low interest rate environment.  Offsetting this
decline was an increase in interest on other interest-bearing liabilities,
which included federal funds purchased, FHLB borrowings, and other
interest-bearing liabilities, of $286 thousand and $383 thousand for the 2004
three month and nine month periods compared to the 2003 periods.  This increase
resulted primarily from costs associated with asset liability management
transactions entered into during the 2004 periods that were not transacted during
the 2003 periods which utilized funding sources other than traditional deposits
to fund growth in interest earning assets.

Average interest-earning assets
increased $76.3 million and $66.4 million to $889.4 million and $857.4 million
for the three and nine months ended September 30, 2004, respectively, compared
to the same 2003 periods. These increases were due in part to a $41.4 million
and $20.0 million increase in the Company's average securities available for
sale during the three and nine months ended September 30, 2004, respectively,
due to management's decision to employ funds obtained through alternative funding sources into higher
yielding earning assets. Average interest-earning assets also increased as a
result of growth in the Company's average loans and loans held for sale
portfolio, which increased $52.1 million and $54.7 million during the three and
nine months ended September 30, 2004, respectively, compared to the same 2003
periods. These increases were mainly due to growth in the commercial real
estate, mortgage, and prime access loan portfolios. These increases in average
interest-earning assets were partially offset by a decline in average federal
funds sold of $17.5 million and $8.8 million, during the three and nine months
ended September 30, 2004, respectively.  Federal funds sold represent unsecured
overnight funds sweeps to other financial institutions by the Company used to
fully utilize the
Company's supply of excess lendable funds.  As such, these balances fluctuate
on a daily basis depending on the liquidity position of the Company.

In addition to the increase in average interest-earning
assets, the Company experienced an increase in average interest-bearing
liabilities. Average interest-bearing deposits increased $24.6 million and
$36.2 million for the three and nine months ended September 30, 2004 over the
same periods of 2003, respectively. Average retail repurchase agreements
increased $7.0 million and $4.3 million from the three and nine months ended
September 30, 2003.  Offsetting these increases was a slight decline in average
commercial paper for the three and nine months ended September 30, 2004 over
the same periods ended 2003. Average other interest-bearing liabilities
increased $39.7 million and $20.8 million for the three and nine months ended
September 30, 2004, respectively, compared to the same 2003 periods and were
used to fund loan growth and securities purchases. This increase is primarily
the result of management's decision during 2004 to utilize FHLB borrowings to support earning
asset growth, including increases in investment securities.

30




The weighted average yield on interest-earning assets and
weighted average cost of interest-bearing liabilities shown in the previous
tables are derived by dividing interest income and expense by the weighted
average balances of interest-earning assets or interest-bearing liabilities.
Interest-sensitive liabilities repriced to an average cost of 1.54% during the
third quarter of 2004 from an average cost of 1.57% during the third quarter of
2003 and 1.47% for the first nine months of 2004 from 1.67% for the same period
of 2003.  Average yields on interest-earning assets declined from 6.07% to
5.93% and 6.42% to 5.97% over the same periods. The decline of the weighted
average yield on interest-earning assets during 2004 periods over 2003 periods
was primarily the result of the decreasing yields of the loan portfolio
resulting from the low interest rate environment, partially offset by increased
security portfolio yields.  The overall decline on weighted average yield on
interest-earning assets was offset partially by a reduction in the weighted
average yield on interest-bearing liabilities. The reduction in the average
yield on interest-bearing liabilities is the result of a reduction in the
average yield on interest-bearing deposits offset somewhat by an increase in
the average yield on other interest-bearing liabilities.  The average yield on
interest-bearing deposits remains a low cost of funds as interest rates on such
accounts remain at lower limits due to historically low interest rates.
Included in the average yield on other interest-bearing liabilities is the cost
of alternative funding
sources utilized by management during 2004.

Impacted by the factors noted in the
preceding paragraph, fully tax-equivalent net yield on interest-earning assets
decreased 13 basis points to 4.63% for the quarter ended September 30, 2004
from 4.76% for the same quarter ended September 30, 2003 and 30 basis points
from the nine month period ended September 30, 2003 to the same period ended
September 30, 2004.

Management
believes that the primary cause of the changes in the yields and rates on
interest-earning assets and interest-bearing liabilities has been the action of
the Federal Reserve Open Market Committee during the past several years. During 2003, the Federal Reserve
lowered the federal funds target rate 25 basis points at the end of June, which
followed a 50 basis point reduction in November 2002 and eleven downward
adjustments in 2001. A large portion of the adjustable rate loans in the loan
portfolio reprice immediately following an interest rate change by the Federal
Reserve. The Federal Reserve increased rates at the end of the second quarter
2004 by 25 basis points.  This increase was followed by two additional
increases, each of 25 basis points, during third quarter 2004.  In spite of
these rate increases, funding source rate changes often
take more time to filter into the net interest margin, primarily because of the
timed maturities of certificates of deposit and borrowings.

Noninterest
IncomeSources of noninterest income include, but are not limited to, fees on
deposit accounts as well as income from the Company's other nontraditional
banking services. Also, as a part of the Company's management of its securities
portfolio, noninterest income is recognized on the sale of securities.

Noninterest
income for the three months ended September 30, 2004 totaled $3.7 million, down
$105 thousand, or 2.7%, compared with $3.8 million for third quarter 2003. This
decline was primarily due to a decline in investment security gains over the
periods presented.

The primary objective of the management of the investment portfolio is to
maintain a portfolio of high quality, highly liquid investments yielding
competitive returns. In order to achieve this objective, the mix of securities
within the portfolio has shifted over the past 15 months resulting in a limited
amount of investment security gains available to be realized.  In addition, the
initiative to restructure the portfolio has resulted in the Company realizing
losses on securities sold to properly align the mix of securities in the
portfolio.

31




Noninterest income for the nine months ended September 30,
2004 totaled $11.3 million, up $286 thousand, or 2.6%, compared with $11.0
million for same period of 2003. The increase in noninterest income during the
first nine months of 2004 over the first nine months of 2003 resulted from an
increase in net fees for trust and brokerage services of $163 thousand, or 8.4%
over the periods presented to a balance of $2.1 million as of September 30,
2004 and an increase in mortgage banking income of $234 thousand during the
first nine months of 2004 over the same period of 2003, offset by a decline of
investment security gains of $272 thousand to a balance of $90 thousand for the
nine month period ended September 30, 2004.

Net fees for trust and brokerage
services include fees earned through both brokerage and trust activities. At
September 30, 2004, assets under Palmetto Capital's management totaled $136.9
million as compared to of $100.8 million at September 30, 2003. At September
30, 2004, assets under the trust department's management totaled $260.1 million
as compared to $246.7 million at September 30, 2003. The 8.4% increase in fees
earned when comparing the nine months ended September 30, 2004 to the same
period of 2003 correlates to the level of assets under management.

Mortgage banking income includes origination income,
mortgage servicing loss (net of the related amortization for the mortgage
servicing rights for portfolio mortgage loans), losses and recoveries related
to the impairment of mortgage servicing rights, and gains and losses on sales
of portfolio mortgage loans. The Company sells most of the loans it originates in the secondary
market with servicing rights retained. At September 30, 2004, the servicing
portfolio for loans sold had an aggregate principal balance of $267.3 million, down from $269.9 million at
December 31, 2003. The servicing portfolio has remained relatively unchanged
over these periods due to prepayments of loans from increased refinancings
resulting primarily from lower rates nearly offsetting new originations. At
September 30, 2004, the total servicing portfolio, including those serviced for
in house loans, had an aggregate principal balance of $320.3 million, up from
$316.0 million at December 31, 2003.

Mortgage banking income decreased $6 thousand during the
three month period ended September 30, 2004 over the same period of 2003. 
Mortgage banking income increased $234 thousand during the nine month period
ended September 30, 2004 over the same period of 2003.  The following table
summarizes the components of mortgage banking income for the nine month period
ended September 30, 2004 compared with the same period of 2003 (in thousands).

For the nine months endedSeptember 30,2004
   
   2003Mortgage servicing fees
   $     504
   
   476Gain on sale of loans
   479
   
   1,122Mortgage servicing right amortization
   -
   
   (133)Mortgage servicing right impairment
   (590)
   
   (1,419)Processing fees
   77
   
   258Other mortgage banking income
   69
   
   1$     539
   
   305


Activity impacting the Company's
mortgage servicing rights portfolio, including mortgage loans originated to be
sold and sales of such loans, are reflected in the Consolidated Statement of
Cash Flows. As management projected in its Annual Report on Form 10-K for
the year ended December 31, 2003, due to the interest rate environment,
residential mortgage production during the first nine months of 2004 has
declined compared with recent years, resulting in reduced loan sale gains. 
Processing fees relating to the origination of such loans also declined over
the same periods.  This
decline is primarily due to the Company negotiating these fees in order to
compete in the challenging lending market. Offsetting these declines in mortgage
banking income was a decline in the amortization and impairment of mortgage servicing rights.  As
interest rates have begun to rise in recent months, refinancing activity have
begun to slow.  As such, the component of mortgage servicing right amortization
and impairment relative to refinancing activity has slowed as well. Over the
periods summarized above, mortgage servicing fees have remained relatively
unchanged as loan prepayments have been replaced with new originations thereby
leaving the loans serviced for others portfolio relatively unchanged.

32




Investment security gains declined from a balance of $362 thousand for
the nine months ended September 30, 2003 to a balance of $90 thousand for the
nine months ended September 30, 2004 for the same reasons that investment
security gains declined in the three months ended September 30, 2004 as
compared with the same period during the prior year, as discussed above.

The
increase in other noninterest income for the nine months ended September 30,
2004 from the nine months ended September 30, 2003 was the result of changes in
several accounts, none of which constitute material fluctuations but that in
the aggregate resulted in an increase of $134 thousand.

Noninterest
ExpenseIn the more competitive financial
services market of recent years, management has recognized the importance of
controlling noninterest expense to maintain and improve profitability.
Management also recognizes that there are compliance costs that continue to
increase as a result of the present operating climate for regulated financial
institutions. The technical and operating environment for financial
institutions continues to require a well-trained and motivated staff, superior
operating systems, and sophisticated marketing efforts.

The increase in noninterest expense for the three months ended September 30, 2004 from the three months ended September 30, 2003 was the result of fluctuations in several accounts.  Salaries and other personnel expense declined by 5.2% over the periods noted, due in part to reduced expenses related to the Company's pension plan. Offsetting this decline was an increase in marketing and advertising expense from the three month period ended September 30, 2003 to the same period of 2004.  Over this period, such expenses increased $90 thousand or 46.2%. The majority of the increase in marketing and advertising expense occurred in conjunction with newspaper advertising and promotions.  In addition to day-to-day operational expenses in each of these areas during the three months ended September 30, 2004, several additional expenses were incurred during the period.  Marketing and advertising expenses were incurred during the third quarter of 2004 relating to the certificate of deposit promotion offered beginning during the second quarter of 2004 as well as expenses incurred in anticipation of an additional certificate of deposit promotion beginning in October 2004.  Additionally, advertising efforts were increased during the third quarter of 2004 to promote the addition of free Internet bill pay to the Seniority Club product.  In addition to these non-routine expenses, in early 2004 a new customer referral program was introduced.  Through the program, customers may earn a prize basket for the referral of new customers.  Expenses related with the advertising and prizes for this program contributed to the increase promotion related marketing and advertising expenses during third quarter 2004 over the same quarter of 2003. The last major fluctuation within noninterest expense was an increase in professional service expense of $187 thousand from the quarter ended September 30, 2003 to the same quarter of 2004, due in part to costs of compliance with the Sarbanes-Oxley Act of 2002 (the "Act") and other recently issued regulatory pronouncements. The remainder of the increase in professional service expense over the periods noted is due to increased legal expenses relating to the loan portfolio.  As noted within the loan footnote included in Notes To Interim Consolidated Financial Statements, the Company has continued to see an increase in prime access loans at September 30, 2004 over December 31, 2003 primarily resulting from the no closing costs promotional offering for such loans.  Synonymous with the increase in this loan portfolio is the increase in the related legal expenses incurred in conjunction with the no closing cost promotion.  Otherwise, the increase in this noninterest expense is the result of costs incurred by the Company to defend itself against litigation brought about in the normal course of lending operations.

33



---



The increase in noninterest expense for the nine months ended September 30, 2004 from the nine months ended September 30, 2003 was also the result of fluctuations in several accounts.  Over the periods noted an increase of $169 thousand was experienced related to occupancy and furniture and equipment expense.  This increase related to several factors including, but not limited to, depreciation related to the upfit of several existing branch facilities, depreciation related to the September 2003 purchase of a parcel of commercial property and improvements (currently occupied through lease agreement) neighboring an existing branch facility in Greenville County purchased for possible future expansion, and additional property taxes related to real property purchased for possible future expansion.  These increases in occupancy and furniture and equipment expense for the nine months ended September 30, 2004 from the nine months ended September 30, 2003 were offset slightly by rental income received during 2004 related to the commercial property and improvements purchased in Greenville County. When comparing the nine months ended September 30, 2004 with the nine months ended September 30, 2003, marketing and advertising expense increased $239 thousand. Although one certificate of deposit promotion was offered during the second quarter of 2003, the promotions offered thus far in 2004, in response to the increasing competition for market share in the market in which the Company competes, have greatly outnumbered the promotions of 2003.  As such, expenses incurred to market these promotions have also increased.  New deposit product promotions as well as other marketing promotions introduced during 2004 are discussed in the preceding paragraph. Another major fluctuation within noninterest expense when comparing the nine month period ended September 30, 2004 to the same period of 2003 was an increase in professional service expense of $315 thousand. Factors in the increase in professional service expenses over the periods presented relate to expenses related to the costs of compliance with the Sarbanes-Oxley Act of 2002 and other recently issued regulatory pronouncements as well as expenses related to the no closing cost promotion related to home equity loans. Offsetting these increases in other noninterest expense financial statement line items for the nine months ended September 30, 2004 over the nine months ended September 30, 2003 was a decline in postage and supplies expense of $228 thousand.  During the first six months of 2003, supply inventories were evaluated and obsolete items were written off.  These write offs totaled approximately $100 thousand.  After adjusting for this write off, postage and supply expenses between the periods declined primarily due to more aggressive expense management.

Income
TaxesTotal income tax expense for the third quarter of 2004 was $1.5 million
for an effective tax rate of 32.0%, compared with income tax expense of $1.2
million for an effective tax rate of 30.2% for the third quarter of 2003.
Income tax expense for the nine months ended September 30, 2004 totaled $4.2
million for an effective tax rate of 32.0%, compared with $3.9 million for an
effective tax rate of 31.7% for the same 2003 period. The increase in the
effective tax rate for 2004 was primarily due to an increase in projected
taxable income relative to nontaxable adjustments. Management anticipates the
2004 effective tax rate to range from 31 to 33 percent.

BALANCE
SHEET REVIEW

The
following discussion is intended to supplement any information relating to the Consolidated
Balance Sheetspresented in the Notes To Interim Consolidated Financial
Statements.

Investment Securities Available for SaleThe securities portfolio, all of which
is classified as available for sale, is a component of the Company's
asset-liability management strategy. Securities available for sale are
accounted for at fair value, with unrealized gains and losses recorded net of
tax as a component of other comprehensive income in shareholders' equity. A
third party determines the fair value of the securities portfolio. The
valuation is determined as of the date of the end of the reporting period based
on available quoted market prices or quoted market prices for similar
securities if a quoted market price is not available.

34




The primary objective of the
management of the investment portfolio is to maintain a portfolio of high
quality, highly liquid investments yielding competitive returns. These
objectives are achieved through specific transaction approvals from the
Company's Board of Directors. The Company is required under federal regulations
to maintain adequate liquidity to ensure safe and sound operations. Investment
decisions are made by authorized officers within policies established by the
Board of Directors. Investment balances are maintained based on a continuing
assessment of cash flows, the level of loan production, current interest rate
risk strategies, and the assessment of the potential future direction of market
interest rate changes. Investment securities may differ in terms of default
risk, interest risk, liquidity risk, and expected rate of return. Default risk
is the risk that an issuer will be unable to make interest payments or to repay
the principal amount on schedule. United States Government obligations are
regarded as free of default risk. The issues of most government agencies are
backed by the strength of the agency itself plus a strong implication that, in
the event of financial difficulty, the federal government would assist the
agency.

The investment securities portfolio serves several purposes
including to manage interest rate and prepayment risk, to leverage capital through
generating interest and dividend income from the investment of funds, to
provide liquidity to meet funding requirements, and to provide collateral for
pledges on public deposits and securities sold under repurchase agreements. The following
table reflects the composition of the investment security available for sale
portfolio at September 30, 2004 and December 31, 2003 (dollars in thousands).

September 30,
   
   
   December 31,2004
   
   
   2003Government agencies
   $
   10,120
   
   6.8%
   
   $
   25,311
   
   19.6%United States treasuries
   
   -
   
   -
   
   
   -
   
   -Municipalities
   
   70,333
   
   47.3
   
   
   55,321
   
   42.9Mortgage-backed securities
   
   68,158
   
   45.9
   
   
   48,298
   
   37.5Total investment securitiesavailable for sale
   $
   148,611
   
   100.0%
   
   $
   128,930
   
   100.0%


At September 30, 2004, the investment securities portfolio grew to 15.4% of total assets from 14.4% at December 31, 2003. Unrealized net gains on securities available for sale were $2.1 million at September 30, 2004 compared to $1.6 million at December 31, 2003. During the first nine months of 2004, deposit and borrowing growth outpaced loan growth and the resulting excess was employed within the securities portfolio.

As was the case during the year ended
December 31, 2003, investment securities previously held within the agency
portfolio have continued to be realigned into the municipalities and mortgage
backed security portfolios in order to meet the objectives of the portfolio.
The continued shift within the investment portfolio during the nine month
period ended September 30, 2004 also reflects the policy of concentrating on
total return as mortgage backed and municipals are expected to outperform on a
total return basis in a rising interest rate environment. This realignment has
resulted in an increase in the duration of the portfolio as the securities
added have longer durations.  The weighted average life and duration of the securities portfolio is
maintained to limit overall exposure, which also provides adequate flexibility
to proactively manage cash flow as market conditions change. The average
weighted life of our securities available for sale portfolio was 3.59 years at
September 30, 2004. Although, a rising interest rate environment typically
negatively impacts the yield curve for the securities available for sale
portfolio by increasing the unrealized net losses within the portfolio, the
Company has not experienced this trend due to the increase in duration as well
as a flattening of the yield curve.  The
rate paid for longer-term securities is typically lower than those paid for
short term securities.

Changes in interest rates and related prepayment activity
impact yields and fair values of securities, specifically mortgage backed
securities. Based on the current investment portfolio composition, in a rising
interest rate environment, related prepayment activity should decrease.
Decreasing prepayment activity extends the premium amortization period, thereby
improving yields.

35




Investment securities, fully tax-equivalent, including the
unrealized gain or loss on available for sale securities, averaged $150.6
million during the three month period ended September 30, 2004, 37.8% above the
average for the corresponding period in 2003, of $109.3 million. For the nine
month period ended September 30, 2004 such securities averaged $130.9 million
compared with $110.9 million for the same period of 2003. The majority of the
increase was attributable to securities purchased to leverage available
capital. The fully tax-equivalent average portfolio yield, including the
unrealized gain or loss on available for sale securities, increased for the
three months ended September 30, 2004 to 4.43% from 3.14% in same quarter of
2003. The average portfolio yield increased for the nine months ended September
30, 2004 to 4.24% from 3.75% in same period of 2003.

In
accordance with the investment policy, all investment securities are to be
rated AA - A so the credit risk is minimal. At September 30, 2004, while
security ratings were in compliance with the policy guidelines, approximately
90% of the security portfolio was rated AAA.  Additionally, at September 30,
2004, the entire MBS portfolio is fixed rate.

The net unrealized gain on available for sale securities
(pre-tax) totaled $2.1 million at September 30, 2004, up from a gain of $1.6
million at December 31, 2003. The increasing trend of the unrealized position
of available for sale securities at September 30, 2004 over the other periods
presented results from the recent restructuring of the portfolio.  Beginning in
late 2003, the securities available for sale portfolio was restructured to
assist in the stabilization of cash flows and the improvement of effective
yields in the portfolio. This shift has continued during the first nine months of
2004.  In addition, during the second quarter of 2004, the Company borrowed $30
million in long term FHLB borrowings and employed these funds in higher yielding earning assets. These events
led to a lengthened duration within the portfolio resulting in an increase in
unrealized gains within the portfolio when comparing December 31, 2003 and
September 30, 2003. At
September 30, 2004 the Government agencies portfolio was in an unrealized gain
position of $47 thousand, the municipal portfolio had an unrealized gain
position of $1.6 million, and the mortgage-backed securities portfolio had an
unrealized gain of $407 thousand.

Investment securities available for
sale were impacted by purchases, proceeds from the sale, maturity, and / or
call of such maturities as well as principal paydowns of mortgage-backed
securities, which is reflected in the Consolidated Statement of Cash Flows.

Other
InvestmentsIn addition
to the investments described in the preceding paragraphs, other investments in securities at September 30, 2004
include FHLB common stock of $2.7 million. The Bank, as a member of the FHLB, is
required to acquire and hold shares of capital stock in the FHLB based
generally upon the Bank's balances of residential mortgage loans and FHLB
borrowings. The Bank was in compliance with this requirement at September 30,
2004.

Loans Held for SaleLoans held for sale consists primarily
of 15 and 30 year mortgages which the Company intends to sell as whole loans.
Loans held for sale are carried at the lower of aggregate cost or market. The
fair value of mortgage loans held for sale is based on the fair market value
for such outstanding commitments to sell these loans. Typically, the carrying
amount approximates fair value due to the short-term nature of these
instruments. Loans held for sale were $3.6 million and $6.4 million at
September 30, 2004 and December 31, 2003, respectively. Loans held for sale
were impacted by originations and sales activity, which are reflected in the Consolidated
Statement of Cash Flows. No valuation allowance to reduce these loans to
lower of cost or market was required at September 30, 2004 or December 31,
2003.

36




Loan Portfolio
Loans represent the most significant
component of interest-earning assets with average loans accounting for 83.9% of
average interest-earning assets for both the nine months ended September 30,
2004 as well as the year ended December 31, 2003. The Company strives to
maintain a diversified loan portfolio in an effort to spread risk and reduce
exposure to economic downturns that may occur within different segments of the
economy, geographic locations, or in particular industries. The loan portfolio consists
principally of commercial loans, commercial real estate loans, consumer loans,
indirect dealer loans, and mortgage loans. The loan portfolio is diversified, and
the Bank's business is not dependent on any single customer or industry, or a
few customers or industries. Although loans may be originated outside of South
Carolina, the majority of the loan portfolio is originated in the market area
of Upstate South Carolina. Certain risks are inherent within any loan
portfolio.  For a discussion of such risks see the Company's Annual Report on
Form 10-K for the year ended December 31, 2003.

At
September 30, 2004, loans outstanding, excluding mortgage loans held for sale,
were $747.0 million, which equaled 77% of total assets.  Total loans
outstanding at December 31, 2003 totaled $693.2 million.

Deposits
Retail deposits have traditionally been the primary source
of funds for the Company and also provide a customer base for the sale of
additional financial products and services. The Company faces stiff competition from other banking and
financial services companies in gathering deposits. For both the three and nine
month periods ended September 30, 2004 over the same periods of 2003, the
percentage of funding provided by deposits has declined, and accordingly, the
Company has developed other sources from which to fund a portion of loan demand
and increases in investment securities. The Company sets strategic targets for net growth in deposit
accounts annually in an effort to cross-sell and thereby increases the products
per banking relationship. During the first nine months of 2004, the Company
emphasized continued emphasis was placed on the growth of deposits through
internal and external referral programs and targeted deposit promotions. During
the second quarter of 2004, a 36-month Step Up Certificate of Deposit ("CD") product
was offered. This product allows a one-time rate "step up."  During early October 2004, another
CD promotion was introduced.  The 15 month CD limited time promotion offers 3.11% APY with an interest rate of 3.067%. In
an effort to facilitate growth in lower-cost transaction based accounts, during the
third quarter of 2004 an enhancement was made to the existing Seniority Club
checking product.  Through this promotion, accounts qualifying for Seniority
Club status will receive the Internet bill pay option at no additional charge. 
Also resulting from the initiative to grow lower-cost transaction based
accounts as well as introduce new banking relationships from which to target
product "bundling," in
early 2004, a new customer referral program was introduced.  Through the
program, customers may earn a prize basket for the referral of new customers.

Traditional deposit accounts, which
include noninterest-bearing
and interest-bearing checking, money market, savings, and time accounts, increased
$11.5 million during the first nine months of 2004. Management believes that
conditions in fiscal 2004, 2003, and 2002 were favorable for deposit growth as
a result of factors such as the low returns on investments and mutual funds
that may have increased traditional deposit inflows although such favorable
conditions were greater in 2002 in the wake of the 2001 terrorist attacks. As
the economy started to show signs of improvement in 2003 coupled with the low
interest rates offered on many deposit accounts, investors began to regain some
confidence, which is reflected by the slowing growth in the deposit portfolio
when comparing the growth during the first nine months of 2004 to the growth
during the first nine months of 2003. The following table reflects the composition
of the traditional deposit portfolio at September 30, 2004 and December 31,
2003 (dollars in thousands). Although growth within the traditional deposit
portfolio was experienced from December 31, 2003 to September 30, 2004, there
was relatively little change in the mix of these deposit accounts.

September 30,
  
  December 31,2004
  
  2003Checking
  $  
  290,508
  37.1%
  
  $  
  288,748
  37.5%Money
  market
  94,755
  12.1
  
  85,077
  11.0Savings
  48,280
  6.2
  
  41,974
  5.4Time
  349,702
  44.6
  
  355,949
  46.1Total
  traditional deposit accounts
  $  
  783,245
  100.0%
  
  $   
  771,748
  100.0%




37




The average cost of these traditional deposits for the quarter ended
September 30, 2004 was 1.53% compared with the average cost of traditional
deposits for the year ended December 31, 2003 of 1.70%. Core deposits, which
include checking accounts, money market accounts, and savings accounts, grew by
$17.7 million during the first nine months of 2004, or 4.3%, while higher
costing time balances decreased by $6.2 million, or 1.8%.  The increase in core
deposits reflects the
Company's efforts to enhance its deposit mix by working to attract lower-cost
transaction accounts. The Company's deposit campaigns and promotions are
expected to play an integral part of achieving this goal. Additionally, the decline in
time balances is the result of increased consumer confidence, which often
results in consumers reallocating investments to less conservative investment
options.

Refer to the tables presented in Management's Discussion and Analysis of Financial Condition
and Results of Operations - Earnings Review which include deposit average balances and rate paid
for the three and nine months ended September 30, 2004 compared with the same
periods of 2003.

Borrowings
The following table reflects the borrowings composition at
the dates indicated (in thousands).

September 30,
   
   
   December 31,2004
   
   
   2003Retail repurchase agreements
   $
   19,779
   
   20.2%
   
   $
   13,525
   
   28.4%Commercial paper
   
   16,564
   
   16.9%
   
   
   16,170
   
   33.9%Federal funds purchased
   
   7,070
   
   7.2%
   
   
   18,000
   
   37.7%FHLB advances, short term
   
   24,500
   
   25.0%
   
   
   -
   
   0.0%FHLB advances, long term
   
   30,000
   
   30.7%
   
   
   -
   
   0.0%Total borrowings
   $
   97,913
   
   100.0%
   
   $
   47,695
   
   100.0%


The Company uses both short-term and long-term borrowings to
fund growth of interest-earning assets in excess of deposit growth. Short and
long term borrowings are a source of funding which the Company may utilize
depending on the current level of deposits, management's willingness to raise
deposits through market promotions, the unused FHLB borrowing capacity, and the
availability of collateral to secure FHLB borrowings. Federal funds
purchased represent unsecured overnight borrowings from other financial
institutions. These borrowings are an important source of funding to the
Company. Access to alternate short-term funding sources allows the Company to
meet funding needs without relying on increasing deposits on a short-term
basis.

During the
second quarter of 2004, the Company began to utilize short term and long term
borrowings from the FHLB.  Short term borrowings typically represent
overnight funds sweeps used to fully utilize the Company's supply of excess lendable funds with
maturities of one year or less when made. Long term borrowings have maturities
greater than one year when made and are collateralized by a blanket lien
on certain qualifying commercial and single-family loans held in the Company's
loan portfolio. The Company may, at its discretion, collateralize such
borrowings with securities from the Company's investment portfolio. FHLB
borrowings are an alternative to other funding sources with similar maturities.

The following table reports information regarding the Company's long term FHLB borrowing
portfolio at September 30, 2004 (dollars in thousands).



Borrowing balance outstanding at September 30, 2004
   $  7,000
   
   13,000
   
   10,000Interest rate
   2.32%
   
   3.27
   
   3.85Maturity date
   6/14/05
   
   6/14/06
   
   6/14/07


38



---



CREDIT RISK MANAGEMENT

GeneralA willingness to take credit risk is inherent in the decision to grant credit. Prudent risk-taking requires a credit risk management system based on sound policies and control processes that ensure compliance with those policies. The Company believes it maintains a conservative philosophy regarding its lending mix, and adherence to underwriting standards is managed through a multi-layered credit approval process and review of loans approved by lenders. Through loan review, reviews of exception reports, and ongoing analysis of asset quality trends, compliance with loan policies is managed.

Loan Grading and Classified AssetsA loan grade classification system is
used for the loan portfolio. Under this classification system, loans graded "1"
represent loans of superior quality. Loans graded "2" represent loans of high
quality. Loans graded "3" represent loans that are satisfactory. Loans graded
"4" represent loans that are considered marginal. Problem assets are classified
as "special mention," "substandard," "doubtful," or "loss," depending on the
presence of certain characteristics.

Assets determined to be problem assets
are reserved at a higher percentage in accordance with the Allowance model than
assets graded superior quality, high quality, satisfactory, or marginal, all
for which general reserves are provided. General allowances represent loss
allowances, which have been established to recognize the inherent risks
associated with lending activities, but which, unlike specific allowances, have
not been allocated to particular problem assets.

At September 30, 2004, there were $3.7 million of loans designated
"special mention," $11.9 million of loans designated as "substandard," $1.4
million of loans designated as "doubtful," and $271 thousand of loans
designated as "loss." At December 31, 2003, there were $4.2 million of loans
designated "special mention," $12.1 million of loans designated as
"substandard," $1.1 million of loans designated as "doubtful," and $213
thousand of loans designated as "loss."

Overall, classified assets decreased
$330 thousand from December 31, 2003 to September 30, 2004. Material increases
were seen in the real estate portfolio offset by declines in the commercial,
financial, and agricultural portfolio as well as the general consumer
portfolio. The 2003 calendar year was a year of considerable economic
uncertainty due in large part to the continued uncertainty following the
terrorist attacks of September 11, 2001 and the United States' presence in
Iraq. Management believes that, although the economy has begun to show signs of
improvement, the residual impact of the weakened economy continued to impact
the classified assets balances within the real estate portfolio through the
first nine months of 2004. The decline in classified assets within the general
consumer portfolio is the result of the loan quality within the current
portfolio believed by management to contain higher-quality indirect loans than
the portfolio has seen in recent years. Additionally, consumers are beginning to see benefits
from job and income growth during 2004, allowing them to better service their
personal consumer debt.

Management periodically reviews its
loan portfolio and has, in the opinion of management, appropriately classified
and established Allowances against all assets requiring classification under
the regulation.

Nonperforming AssetsNonperforming assets are comprised of
nonaccrual loans, other real estate owned ("OREO"), and repossessed
automobiles.

39




Delinquent and problem loans are a
normal part of any lending function. When a borrower fails to make a scheduled
payment with regard to a loan, attempts are made to cure the default through
several methods including, but not limited to, collection contact and assessing
late fees. If these methods do not encourage the borrower to post the past due
payment, further action is taken. Interest on loans deemed past due continues
to accrue until such time that the loan is placed in nonaccrual status (loan
must be placed in nonaccrual prior to any amount being charged-off). Nonaccrual
loans are those loans that management, through its continuing evaluation of
loans, has determined offer a more than normal risk of future collectibility.
In most cases, loans are automatically flagged as nonaccrual by the loan system
when the loan payment becomes 90 days delinquent and no acceptable arrangement
has been made. Loans may manually be flagged as nonaccrual in the loan system
if management determines that some factor other than days delinquent (i.e.
bankruptcy proceedings) cause reason to believe that more than a normal amount
of risk exists in regards to future collection. When the loan is flagged as
nonaccrual, accrued interest income is reversed to the effective date of
nonaccrual status. Thereafter, interest income on the nonaccrual loans is
recognized only as received. When the probability of future collectibility on
nonaccrual loans declines, the Company proceeds with measures to remedy the
default, including commencing foreclosure action, if necessary. Specific steps
must be taken when commencing foreclosure action on mortgage loans secured by
the use of a mortgage instrument.

OREO represents real estate acquired
through foreclosure or deed in lieu thereof and is carried at the lower of cost
or fair value, less estimated costs to sell. Personal property acquired in
settlement of loans represents repossessed automobiles.  Such property is also
carried at the lower of cost or fair value, less estimated costs to sell.

Nonaccrual loans at September 30, 2004
decreased to $3.5 million compared to $3.8 million at December 31, 2003. OREO
decreased to $2.1 million at September 30, 2004 from $2.2 million at December
31, 2003. As a result of the Company's continued focus on asset quality and the
initiatives taken in 2003 and in the first half of 2004, our asset quality
ratios remain strong. The following table summarizes the Company's
nonperforming assets and loans 90 days or more past due and still accruing
interest as of the dates indicated.

September 30,
   
   June 30,
   
   March 31,
   
   December 31,
   
   September 30,2004
   
   2004
   
   2004
   
   2003
   
   2003Nonaccrual loans
   $
   3,456
   
   3,044
   
   3,236
   
   3,828
   
   5,180Other real estate owned
   
   2,085
   
   3,074
   
   3,239
   
   2,170
   
   1,919Repossessed automobiles
   
   276
   
   207
   
   166
   
   243
   
   197Total nonperforming assets
   
   5,817
   
   6,325
   
   6,641
   
   6,241
   
   7,296Loans past due 90 days and still accruing (1)
   
   101
   
   91
   
   104
   
   212
   
   158Total nonperforming assets and loans pastdue 90 days and still accruing
   $
   5,918
   
   6,416
   
   6,745
   
   6,453
   
   7,454Nonperforming assets as a percentage ofTotal assets
   
   0.60
   %
   0.67
   
   0.74
   
   0.69
   
   0.83Total loans, OREO, and repossessedautomobiles (2)
   
   0.78
   
   0.88
   
   0.93
   
   0.90
   
   1.08Nonaccrual loans as a percentage of loans (2)
   
   0.46
   
   0.42
   
   0.46
   
   0.55
   
   0.77Ratio of allowance for loan losses to nonaccrualloans
   
   2.36
   x
   2.62
   
   2.38
   
   1.95
   
   1.40


|(1)
	(2) | Substantially all of these loans are credit card loansCalculated using loans, net of unearned, excluding mortgage loans held for sale
|-------- | -------------------------------------------------------------------------------------------------------------------------------------

Although a decline was experienced in
nonaccrual loans from December 31, 2003 to September 30, 2004, an increase was
experienced for the quarter ended September 30, 2004.  Management anticipated
that nonaccrual loans might increase as some customers continue to experience
difficulties in this current economic environment. Management has taken current
economic conditions into consideration when estimating the allowance for loan
losses.

40




The Company experienced relatively
little change in the mix of nonaccrual loans at September 30, 2004 when
compared with those at December 31,2003. At December 31, 2003, nonperforming loans were comprised
of 71.0% of loans secured by real estate, 17.7% of commercial and industrial
loans, and 11.3% of loans to individuals for household, family, and other
personal expenditures. At September 30, 2004, nonperforming loans were
comprised of 65.6% of loans secured by real estate, 23.6% of commercial and
industrial loans, and 10.8% of loans to individuals for household, family, and
other personal expenditures. Management believes the decrease experienced in
total nonperforming loans over the time periods noted is a reflection of
management's more aggressive approach to managing loans.  Prior to recent times that have
experienced increased bankruptcies and job losses, more flexibility was given
for borrowers to make payments when they became delinquent. However, in
response to the current economic times, more strict collection policies have
been applied to such loans.

Real estate and automobiles acquired
as a result of repossession, foreclosure, or by deed in lieu of foreclosure are
classified within "other assets" on the Consolidated Balance Sheets
until such time that it is sold. When property is acquired, it is recorded at
the lower of cost or estimated fair market value less cost to sell at the date
of acquisition, with any resulting write downs being taken through the
Allowance. Any subsequent write downs are taken through the Consolidated
Statements of Income. Costs relating to the development and improvement of
such property are capitalized, and costs relating to holding the property are
charged to expense. Based on current information available to management at
September 30, 2004, it is believed that both properties were recorded at the
lower of cost or estimated fair market value less cost to sell.

The following table summarizes the
changes in the real estate acquired in settlement of loans portfolio, including
the balance at the beginning and end of each period, provision charged to
income, and losses charged to the Allowance (in thousands).



For the nine
  
  For themonths ended
  
  year endedSeptember 30, 2004
  
  December 31, 2003Balance,
  beginning of period
  $                         
  2,170
  
  2,468AddNew real
  estate acquired in settlement of loans
  1,581
  
  1,595LessSales of
  real estate acquired in settlement of loans
  1,440
  
  1,534Losses
  charged to the Allowance
  116
  
  191Provision
  charged to expense
  110
  
  168Balance,
  end of period
  $                        
  2,085
  
  2,170


Due to the relatively low volume of properties within the
other real estate owned portfolio, the foreclosure of new property or the sale
of an existing property can cause the balance to fluctuate substantially.  Fluctuations
of these balances relate primarily to current economic conditions, which
directly impact the borrower's ability to service their debt. Of the $1.6
million added to the real estate acquired in the settlement of loans portfolio
during the first nine months of 2004, only $343 thousand was added during the
third quarter.  Policy requires that appraisals be obtained on properties at
the time that they are transferred into the real estate portfolio.  Based on
current information available to management at September 30, 2004, it is
believed that properties were recorded at the lower of cost or estimated fair
market value less cost to sell.  Additionally, all but $225 thousand of the
sales from the portfolio occurred during the third quarter of 2004.  Management
believes that the properties within the portfolio are marketable and the recent
signs of improvement within both the local and national economy will positively
impact the sale of the remaining properties within the portfolio.

Bankcard balances are typically
excluded from the nonaccrual process noted above. Due to the nature of the
portfolio, it is not necessarily probable that collectibility of these loans is
remote when delinquencies exceed 90 days. For this reason, these balances often
continue to accrue income after they have become greater than 90 days past due.
Although these balances declined significantly at September 30, 2004 over
December 31, 2003, balances have remained relatively consistent since that
time.  Such balances were less than 1% of the bankcard portfolio principal
balance at September 30, 2004.

41




Allowance for Loan Losses 
The Allowance is maintained at a level that management believes is
sufficient to cover inherent losses in the loan portfolio at a specific point
in time. Assessing the adequacy of the Allowance requires considerable
judgment. The adequacy of the Allowance is analyzed on a monthly basis using an
internal analysis model. For purposes of this analysis, adequacy is defined as
a level sufficient to absorb probable losses in the portfolio. An Allowance
model is used that takes into account factors including the composition of the
loan portfolio including risk grade classifications (based on an internally
developed grading system as described in Loan Portfolio), historical asset
quality trends including, but not limited to, previous loss experience ratios,
management's assessment of current economic conditions, and reviews of specific
high risk sectors of the portfolio. Management's judgments evolve from an assessment of various
issues, including but not limited to, the pace of loan growth, new product
offerings and characteristics, loan portfolio quality trends, and uncertainty
in current economic and business conditions. Loans are graded at inception
and are reviewed on a periodic basis to ensure that assigned risk grades
continue to be proper based on the definition of such classification. The value
of underlying collateral is also considered during this analysis. The resulting
monthly Allowance model and the related conclusions are reviewed and approved
by senior management.

The Company's Allowance model includes
considerations for valuation allowances computed on impaired loans in accordance
with SFAS No. 114, "*Accounting by Creditors for Impairment of a Loan-an
amendment of FASB Statements No. 5 and 15,"*if applicable, valuation
allowances for certain classified loans, valuation allowances determined by
applying historical loss rates to those loans not considered impaired, and
valuation allowances for factors which management believes are not reflected in
the historical loss rates or that otherwise need to be considered when
estimating the allowance for loan losses. These four components are estimated
monthly in conjunction with the monthly preparation of the Allowance model. The
model output is used by management as a guide in determining the adequacy of
the allowance for loan losses.

All estimates of loan portfolio risk,
including estimates made in conjunction with the analysis of the adequacy of
the allowance for loan losses, are subject to general and local economic
conditions, among other factors, which are unpredictable and beyond the
Company's control. Since a significant portion of the loan portfolio is
comprised of real estate loans and loans to area businesses, the Company is
subject to risk in the real estate market and changes in the economic
conditions in its primary market area. Changes in these areas can increase or
decrease the provision for loan losses.

The methodology for assessing the
adequacy of the Allowance establishes both an allocated and unallocated
component. The allocated component is based principally on current loan grades
and historical loss rates. The unallocated component estimates probable losses
in the portfolio that are not fully captured in the allocated Allowance. These
analyses include, but are not necessarily limited to, industry concentrations,
model imprecision, and the estimated impact of current economic conditions on
historical loss rates. On a continual basis, management monitors trends within
the portfolio, both quantitative and qualitative, in order to assess the
reasonableness of the unallocated component.

The following table sets forth the activity
in the Allowance at and for the dates indicated (dollars in thousands). Please
note that losses and recoveries are charged or credited to the Allowance at the
time realized.

42




For the three months
			
			
			
			For the nine monthsended September 30,
			
			
			
			ended September 30,(Dollars in
			thousands, except share data)
			2004
			
			2003
			
			
			
			2004
			
			2003Balance, beginning
			of period
			$  
			7,983
			
			7,022
			
			
			
			7,463
			
			6,402Loan charge-offsLoans secured by
			real estateSecured by 1-4
			family residential property
			56
			
			162
			
			
			
			164
			
			485Secured by nonfarm
			nonresidential property
			88
			
			43
			
			
			
			224
			
			43Commercial and
			industrial
			124
			
			254
			
			
			
			341
			
			521Credit cards
			96
			
			135
			
			
			
			308
			
			345Other loans to
			indivuduals for household, family, or other personal expenditures
			147
			
			139
			
			
			
			520
			
			601Total loans
			charged-off
			511
			
			733
			
			
			
			1,557
			
			1,995Recoveries from
			loans previously charged-offLoans secured by
			real estateSecured by 1-4
			family residential property
			-
			
			-
			
			
			
			-
			
			-Secured by nonfarm
			nonresidential property
			-
			
			1
			
			
			
			4
			
			1Commercial and
			industrial
			5
			
			32
			
			
			
			27
			
			32Credit cards
			8
			
			5
			
			
			
			14
			
			18Other loans to
			indivuduals for household, family, or other personal expenditures
			35
			
			14
			
			
			
			69
			
			83Total recoveries
			from loans previously charged-off
			48
			
			52
			
			
			
			114
			
			134Net charge-offs
			463
			
			681
			
			
			
			1,443
			
			1,861Provision for loan
			losses
			650
			
			900
			
			
			
			2,150
			
			2,700Balance, end of
			period
			$     
			8,170
			
			7,241
			
			
			
			8,170
			
			7,241Loans (1)
			
			$  747,010
			
			670,850
			
			
			
			747,010
			
			670,850Average loans (1)
			730,088
			
			667,042
			
			
			
			714,017
			
			651,687Net charge-offs to
			average loans (annualized) (1)
			0.25
			%
			0.41
			
			
			
			0.27
			
			0.38Allowance for loan
			losses to loans
			1.09
			x
			1.08
			
			
			
			1.09
			
			1.08(1)
			Calculated using
			loans, net of unearned, excluding mortgage loans held for sale




Total loan
charge-offs decreased when comparing both the three and nine month periods
ended September 30, 2004 with the same periods of 2003.  When comparing these
periods, material fluctuations from period to period included decreases within
the secured by one to four family real estate loan portfolio, the commercial
and industrial loan portfolio, and the credit card portfolio. Management believes that these
fluctuations can be attributed to the recent interest rate environment and the
general economic condition both locally and nationally, which has led to
increased consumer debt incurrence and refinancing, as well as the recent
indications of economic recovery including improvement in job opportunities
within our communities making consumers better able to service their debt. 
These improving conditions in the economy also impact the manufacturing sector,
which in turn impact a company's ability to service its debt. Total
recoveries from loans previously charged-off remained relatively unchanged when
comparing both the three and nine month periods ended September 30, 2004 with
the same periods of 2003.

The
Allowance is subject to examination and adequacy testing by regulatory
agencies, which may consider such factors as the methodology used to determine
adequacy and the size of the Allowance relative to that of peer institutions,
and other adequacy tests. In addition, such regulatory agencies could require
us to adjust our Allowance based on information available to them at the time
of their examination.

43




Management considers the allowance for
loan losses adequate to cover inherent losses in the loan portfolio as of the
date of the financial statements. Management believes it has established the
allowance in consideration of the current economic environment. While
management uses the best information available to make evaluations, future
adjustments to the allowance may be necessary based on changes in economic and
other conditions.

Provision
for Loan LossesThe provision for loan losses is a charge to earnings in a
given period in order to maintain the Allowance for loan losses at an adequate
level defined by the Allowance model. Accordingly, the factors which influence
changes in the allowance for loan losses have a direct impact on the provision
for loan losses. The Allowance for loan losses changes from period to
period as a result of a number of factors, the most significant of which for
the Company include changes in the mix of types of loans, current charge-offs
and recoveries of loans, changes in impaired loans, changes in valuations for
certain performing loans which have specific allocations, changes in credit
grades within the portfolio, which arise from a deterioration or an improvement
in the performance of the borrower changes in historical loss percentages, and
changes in the amounts of loans outstanding, which are used to estimate current
probable loan losses. In addition, the Company considers other, more subjective
factors, which impact the credit quality of the portfolio as a whole and
estimates allocations of allowance for loan losses for these factors, as well.
These factors include loan concentrations, economic conditions, and operational
risks. Changes in these components of the allowance can arise from fluctuations
in the underlying percentages used as related loss estimates for these factors,
as well as variations in the portfolio balances to which they are applied. The
net change in all of these components of the allowance for loan losses results
in the charge to the provision for loan losses.

The provision for loan losses was $650 thousand and $900
thousand for the three months ended September 30, 2004 and 2003, respectively. 
The provision for loan losses was $2.2 million and $2.7 million for the nine
months ended September 30, 2004 and 2003, respectively.

The declines in the provision for loan losses for both the
three and nine months ended September 30, 2004 compared with the same periods
of 2003 were caused by the decline in nonperforming assets over the past 180
days, the decline in net charged-off loans for both the three and nine month
periods ended September 30, 2004 when compared with the same periods of 2003,
and the decline of classified assets during the first nine months of 2004. 
Management believes that loss exposure in the loan portfolio is identified,
adequately reserved in a timely manner, and closely monitored to ensure that
changes are promptly addressed in its analysis of Allowance adequacy. 
Accordingly, management believes the Allowance at September 30, 2004 is
adequate based on its assessment of probable losses and available facts and
circumstances then prevailing.  Management's judgments regarding
Allowance model inputs, which are believed to be reasonable, may or may not
prove valid in the future. Thus, there can be no assurance that loan losses in
future periods will not exceed the current Allowance allocation or that future
increases in the Allowance will not be required, adversely impacting operating
results.

MARKET
RISK MANAGEMENT

Asset-Liability Management and
Interest Rate RiskMarket risk is the risk of loss from
adverse changes in market prices and rates. Market risk arises principally from
interest rate risk inherent in lending, deposit, borrowing, and investing
activities that could potentially reduce net interest income in future periods.
This risk can also be reflected in diminished current market values. Management
actively monitors and manages its interest rate risk exposure. Although other
risks, such as credit and liquidity risk, are managed in the normal course of
business, management considers interest rate risk to be its most significant
market risk. This risk could potentially have the largest material effect on
the Company's financial condition and results of operations. Other types of
market risks, such as foreign currency exchange rate risk and commodity price
risk, do not arise in the normal course of the Company's business activities.

44




Because net interest income of any
financial institution is vulnerable to fluctuations in interest rates,
management attempts to mitigate this vulnerability through effective
Asset-Liability Management. Such Asset-Liability Management should maintain a
balance between exposure to interest rate fluctuations and earnings. The
Company defines Asset-Liability Management as the process by which changes occur
to the mix, maturity, and pricing of assets and liabilities in an attempt to
reduce a materially adverse impact on earnings resulting from the direction,
frequency, and magnitude of change in market interest rates realizing that a
sudden and / or substantial fluctuation in interest rates will impact earnings
to the extent that the interest rates on interest-earning assets and
interest-bearing liabilities do not change at the same speed, to the same
extent, or on the same basis. The Company's goal then is to minimize interest
rate risk between interest-earning assets and interest-bearing liabilities at
various maturities through its Asset-Liability Management. Through
Asset-Liability Management, the Company seeks to achieve steady growth of net
interest income with an acceptable amount of interest rate risk and sufficient
liquidity.

Appropriate overall balance sheet
parameters and guidelines are influenced by general economic and banking
conditions and by the local market environment. Current parameters and
guidelines of the Asset-Liability Committee include maintaining the loan to
deposit ratio in a range of 75% to 90%, using an increase or decrease of 3% in
the federal funds rate over a twelve month period as a trigger for minimizing
exposure to interest rate shifts, maintaining a liquidity ratio as defined by
regulators in a range of 10% to 25%, and maintaining a dependency ratio as
defined by the regulators of 5% to 25%. It is noted that the projected negative
impact on net interest income for the twelve month period is not to exceed 20%
although management may have to take corrective action during a period of
sharply rising or falling interest rates. At September 30, 2004, the Company's
loan to deposit ratio, as calculated based on the Board approved definition,
was 89.95%, which falls within the policy's permitted range of 75% to 90%, and
the liquidity ratio was 16%, which falls in the policy's permitted range of 10%
to 25%.

One tool the Company utilizes in
assessing Asset-Liability Management is a simulation model used to analyze
interest sensitivity gap (the difference between the amount of rate sensitive
assets maturing or repricing within a specific time period and the amount of
rate sensitive liabilities maturing or repricing within the same time period).
Rate sensitive assets
are those repricing within one year and those maturing within one year.  Rate
sensitive liabilities include insured money market accounts, savings accounts,
interest-bearing transaction accounts, time deposits and borrowings.

The following table is a summary of the Company's one-year
gap (dollars in thousands):

September 30, 2004Interest-earning assets maturing or
repricing within one year
			$ 425,686Interest-bearing liabilities maturing or repricing
within one year
			432,088Cumulative gap
			$    (6,402)Gap as a percentage of total assets
			0.01%


The above
analysis does not take into account any prepayments on mortgages, consumer or
other loans, or securities.  All maturities are stated in contractual terms.  The
interest-sensitive gap position, while not a complete measure of interest
sensitivity, is reviewed periodically to provide insights related to the static
repricing structure of assets and liabilities. The static gap position is
limited because it does not take into account changes in interest rates or
changes in management's expectations or intentions. Based on the September 30, 2004
dynamic gap position in a one-year time period $425.7 million in
interest-earning assets will reprice and approximately $432.1 million in
interest-bearing liabilities will reprice. This current dynamic gap position
results in a negative one-year gap position of $6.4 million, or 0.01% of
assets.

A negative gap indicates that cumulative interest-sensitive
liabilities exceed cumulative interest-sensitive assets and suggests that net
interest income would decline if market interest rates increased. A positive
gap suggests the reverse. This relationship is not always ensured due to the
repricing attributes of both interest-sensitive assets and interest-sensitive
liabilities.

45




An important aspect of achieving
satisfactory net interest income is the composition and maturities of
rate-sensitive assets and liabilities. It must be understood, however, that
such an analysis is as of the date noted and does not reflect the dynamics of
the market place. Therefore, management reviews simulated earnings statements
on a monthly basis to more accurately anticipate sensitivity to changes in
interest rates.

The earnings statements reviewed
monthly by management simulates the Company's consolidated balance sheets and
consolidated statements of income under several different rate scenarios over a
twelve month period. It reports a case in which variations occur, from the
Company's most likely forecast, when rates gradually increase and decrease in
increments of 100 basis points up to 300 basis points over the coming twelve
month period. Computation of the possible impact of hypothetical interest rate
changes are based on numerous assumptions, including relative levels of market
interest rates and loan prepayments, and should not be relied upon as
indicative of actual results. Further, the computations do not contemplate any
actions that could be taken in response to changes in interest rates.

In conjunction with the annual
budgeting process for 2004, the Company projected a gradual increase in rates
rather than an immediate change. This projection was made because rates
typically change gradually over time rather than abruptly.

According to the model as of the end
of the third quarter 2004, if interest rates rise by 300 basis points from the
most likely forecast over the
coming twelve month period, net interest income would be adversely affected by
approximately $4.6 million, or 11.1%. This model also shows that if interest
rates rose by only 100 or 200 basis points over the coming twelve month period,
net interest income would be adversely affected by approximately $1.1 million,
or 2.7%, and $2.5 million, or 6.1%, respectively. The model also shows that if
interest rates dropped 300 basis points, net interest income would be adversely
impacted by approximately $4.4 million, or 10.6%. Similarly, if interest rates
dropped by only 100 or 200 basis points over the coming twelve month period,
net interest income would be adversely impacted by approximately $483 thousand,
or 1.2%, and $2.5 million, or 5.9%, respectively. The Asset-Liability Committee
meets weekly to address such interest-pricing issues. The projected negative
impact on net interest income for the twelve month period does not exceed the
20% threshold prescribed by the Asset-Liability Committee's policy as noted
previously.

Off-Balance Sheet
Arrangements
The Company is party to financial
instruments with off-balance-sheet risk in the normal course of business to
meet the financing needs of its customers. These financial instruments include
commitments to extend credit and standby letters of credit. These instruments
involve, to varying degrees, elements of credit and interest rate risk in
excess of the amount recognized in the consolidated financial statements.
Commitments to extend credit are agreements to lend to a customer so long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates and may require collateral from the
borrower if deemed necessary by the Company. Standby letters of credit are
conditional commitments issued by the Company to guarantee the performance of a
customer to a third party up to a stipulated amount and with specified terms
and conditions. See Note 9 of the Notes To Interim Consolidated Financial Statements for further discussion of these off
balance sheet arrangements. The Company does not have any special purpose
entities or off-balance sheet financing arrangements.

LiquidityThe term liquidity refers to the
ability of the Company to generate adequate amounts of cash to meet its needs.
Management determines the desired level of liquidity in conjunction with the
Company's Asset-Liability Committee. The level of liquidity is based on
management's strategic direction for the Company, commitments to make loans,
and the Asset-Liability Committee's assessment of the Company's ability to
generate funds.

46




Proper liquidity management is crucial
to ensure that the Company is able to take advantage of new business
opportunities as well as meet the demands of its customers. In this process,
the Company focuses on assets and liabilities and on the manner in which they
combine to provide adequate liquidity to meet the Company's needs.

Liquidity is impacted by its ability
to attract and retain deposit accounts, activity in and sales from its
investment security and loan portfolios, alternative sources of funds, and
current earnings. Competition for deposits is intense in the markets served by
the Company. However, the Company has been able to attract deposits as needed
through pricing adjustments, expansion of its geographic market area, providing
quality customer service, and through its reputation among the communities it
serves. The deposit base is comprised of diversified customer deposits with no
one deposit or type of customer accounting for a significant portion.
Therefore, withdrawals are not expected to fluctuate significantly from
historical levels. The loan portfolio is a source of liquidity through
maturities and repayments by existing borrowers. Loan demand has been constant,
and loan originations can be controlled through pricing decisions. The
investment securities portfolio is also an avenue for liquidity through
scheduled maturities, sales of investment securities, and prepayment of
principal on mortgage backed securities. The Company feels the risk that demand
for its products and services would reduce the availability of cash from
operations is not significant given the industry in which it operates. Although
rapid technological change could present risks in this area, the Company feels
as though it stays current on such changes. To review how these and other
factors have impacted liquidity, see Consolidated Statements of Cash Flows
contained herein.

Because the Company's sources of liquidity are often subject to various
uncertainties beyond its control, as a measure of protection, alternative
funding sources have been arranged through federal funds lines at correspondent
banks and through the Federal Reserve Discount Window. At September 30, 2004,
the Company had unused short-term lines of credit totaling $33 million.

The FHLB has established an overall
credit limit for any member.  Generally, this limit is 40% of the member's
total assets.  For purposes of overall credit limit, total outstanding
borrowings includes letters of credit and the market value of interest rate
swaps.  However, a member's eligibility to borrow in excess of 30% of assets is
subject to its meeting various criteria prescribed by the FHLB.  Any member
approved for a 40% limit shall be subject to a Collateral Risk Review at its
next scheduled review. Additionally, a member approved for a 40% credit limit
and that continues to meet the preceding eligibility criteria may request
approval to exceed the credit limit on an "over line" basis. A member may
exceed the 40% limit for a period not to exceed 12 months. The FHLB requires
that securities, qualifying single-family mortgage loans, and stock of the FHLB
owned by the Bank be pledged to secure any borrowings from the FHLB. The unused
borrowing capacity currently available from the FHLB (computed as discussed
above) assumes that the Bank's $2.7 million investment in FHLB stock, as well
as certain securities and qualifying mortgages, would be pledged to secure any
future borrowings. At September 30, 2004, $30 million in long term FHLB
borrowings were utilized against this line of credit.

The liquidity ratio is an indication
of the Company's ability to meet its short-term funding obligations. The
Company's policy is to maintain a liquidity ratio between 10% and 25%. At
September 30, 2004, the liquidity ratio was 16%. Management believes that the liquidity sources during
the first nine months of 2004 were adequate to meet its liquidity needs and to
maintain the liquidity ratio within policy guidelines.

Management's review at December 31,
2003 (which analyzes the forward-looking twelve month period) concluded that
its sources of liquidity appeared adequate to meet operational needs and to
maintain the liquidity ratio within policy guidelines.  During the first nine
months of 2004, management was aware of no conditions or events that would
change this conclusion.

47




The
Company's cash needs include general operating expenses and the payment of
dividends and interest on borrowings.  The Company declared and paid cash
dividends totaling $0.14 per share during each of the first three quarters of
2004.  Although there can be no guarantee that additional dividends will be paid
in 2004, the Company plans to continue its quarterly dividend payments.

Note 9 of
the Notes To Interim
Consolidated Financial Statementssummarizes the Company's commitments an excerpt of which is
included below.

Lending Commitments and Off-Balance Sheet Risk
In the normal course of business, the
Company engages in a variety of financial transactions that, in accordance with
generally accepted accounting principles, are not recorded in the financial
statements or are recorded in amounts that differ from the notional amounts.
These transactions involve elements of credit, interest rate, and liquidity
risk. Such transactions are used for general corporate purposes or to meet
customer needs. Corporate purpose transactions are those used to manage customers'
requests for funding.

At September 30, 2004, the Company had no interests in non-consolidated
special purpose entities nor is it involved in other off-balance sheet contractual relationships
(other than those discussed herein), unconsolidated related entities that have
off-balance sheet arrangements, or transactions that could result in liquidity
needs.

The Company makes contractual
commitments to extend credit, which are legally binding agreements to lend
money to customers at predetermined interest rates for a specific period of
time. The Company also provides standby letters of credit. These lending
commitments are provided to customers in the normal course of business and the
Company's credit policies and standards are applied when making these commitments.

At September 30, 2004, the Company had
$167.0 million unused commitments, which included home equity loans, unused
lines of credit related to commercial real estate development, other unused
credit lines, and credit card lines.

Outstanding commitments on mortgage
loans not yet closed, the majority of which include interest rate lock
commitments, amounted to approximately $3.7 million at September 30, 2004.
These were principally single-family loan commitments.

Standby letters of credit represent an
obligation to a third party contingent upon the failure of a customer to
perform under the terms of an underlying contract with the third party, or
obligates the Company to guarantee or stand as surety for the benefit of the
third party. Under the terms of a standby letter of credit, generally, drafts
will be drawn only when the underlying event fails to occur as intended. The
Company can seek recovery of the amounts paid from the borrower. However,
standby letters of credit are generally not collateralized. Commitments under
standby letters of credit are usually for one year or less. At September 30,
2004, the Company has recorded no liability for the current carrying amount of
the obligation to perform as a guarantor and no contingent liability is considered
necessary, as the Company believes the likelihood that it will have to perform
under such contracts is not likely. The maximum potential amount of
undiscounted future payments related to standby letters of credit at September
30, 2004 was $1.6 million. Past experience indicates that many of these standby
letters of credit will expire unused. However, through its various sources of
liquidity, the Company believes that it has the necessary resources to meet
these obligations should the need arise. Additionally, current fair values of
such guarantees were deemed immaterial at September 30, 2004.

48




The Company originates, sells, and
services mortgage loans. All of the loan sales within the first nine months of
2004 were without provision for recourse. Mortgage loans serviced for the
benefit of others, which are not owned by the Company and therefore are not
recorded on the Consolidated Balance Sheets, amounted to $267.3 million
and $269.9 million at September 30, 2004 and December 31, 2003, respectively.

Contingencies
The Company is currently the defendant in
certain legal proceedings and claims that have arisen in the ordinary course of
its business. In the opinion of management based on consultation with external
legal counsel, any reasonably foreseeable outcome of such current litigation
would not materially affect the Company's consolidated financial position or
results of operations.

On May 18, 2004, Glen
Meadows, LLC, WACC, LLC, and BC Ventures, LLC filed a complaint against The
Palmetto Bank and two other financial institutions claiming that a dishonest
employee (of the plaintiffs) deposited checks drawn on company accounts at the
latter two institutions and deposited these funds into the employee's account at
The Palmetto Bank. Although The Palmetto Bank contended that we had no
obligation to the drawer of the checks due to the extended period of time
between the occurrences and the claim, the compliant was settled during the
third quarter of 2004 for $75,000.

Lease Agreements
The Company has not entered into any material property and
equipment leases during the nine month period ended September 30, 2004.

Derivatives
and Hedging ActivitiesDerivative
transactions may be used by the Company to better manage its interest rate
sensitivity to reduce risks associated with its lending, deposit taking, and
borrowing activities. The Company recognizes any derivatives as either assets
or liabilities on the consolidated balance sheets and reports these instruments
at fair value with realized and unrealized gains and losses included in either
earnings or in other comprehensive income, depending on the purpose for which
the derivative is used and whether the derivative qualifies for hedge
accounting in accordance with SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities."

Derivative
instruments expose a company to credit and market risk. Credit risk, the risk
that the counterparty to a derivative instrument will fail to perform, is equal
to the extent of the fair value gain in a derivative. Credit risk is created
when the fair value of a derivative contract is positive since this generally
indicates that the counterparty owes the company. When the fair value of the
derivative contract is negative no credit risk exists since the company would
owe the counterparty. Credit risk in derivative instruments can be minimized by
entering into transactions with high-quality counterparties as evaluated by
management. Market risk is the adverse impact on the value of a financial
instrument from a change in interest rates or implied volatility of interest
rates. Establishing and monitoring limits as to the types and degree of risk
that may be undertaken can manage market risk associated with interest rate
contracts. Any market risk associated with derivatives used for interest rate
risk management is fully incorporated into the Company's interest rate
sensitivity analysis.

The only
derivative activity in which the Company engages is commitments to originate
fixed rate mortgage loans held for sale where the purchasing party undertakes
the interest rate lock risk.  Accordingly, no interest rate risk is involved in
such transactions. Commitments are generally recorded at their fair value at
the date of contract.  The fee collected for such commitments determines such
fair values.

The
Company's accounting policies related to derivative and hedging activities are
discussed in Note 1 of Notes to Consolidated Financial Statements
contained within its Annual Report on Form 10-K for the year ended December 31,
2003.

CAPITAL
MANAGEMENT

The objective of effective capital management
is to generate above market returns on equity to shareholders while maintaining
adequate regulatory capital ratios. The Company uses capital to fund growth,
pay dividends, and, from time to time, repurchase its common stock.

49




Shareholders'
equity totaled $78.8 million and $72.0 million at September 30, 2004 and
December 31, 2003, respectively.  Shareholders' equity as a percentage of total
assets was 8.2% at September 30, 2004 and 8.0% at December 31, 2003.  During the
first nine months of 2004, shareholders' equity was impacted by the retention
of earnings, through stock option activity, and through an increase in the
unrealized gain on investment securities available for sale. Cash dividends
declared and paid during the first nine months of 2004 offset these increases.
The Consolidated Statements of Changes in Shareholders' Equity and
Comprehensive Incomecontained herein provides detail of the changes in
stockholders' equity components during the first nine months of 2004.

During the first nine months of 2004,
the dividend payout ratio was 29.4% compared with a payout ratio of 26.9%
during the same period of 2003. For the year ended December 31, 2003 the
dividend payout ratio was 29.5%. Cash dividends per share for the three months
ended September 30, 2004 totaled $0.14, an increase of 16.7% over dividends per
share for the same quarter of 2003 of $0.12. Cash dividends per share for the
nine months ended September 30, 2004 totaled $0.42, an increase over dividends
per share for the same period of 2003 of $0.36. The amount of dividends per
share declared is dependent on the Company's earnings, financial condition,
capital position, and such other factors as the Board may deem relevant. The
Company and the Bank
are subject to certain regulatory restrictions on the amount of dividends they
are permitted to pay as described in its Annual Report on Form 10-K for the
year ended December 31, 2003.The ability of the Company to pay dividends depends primarily
on the ability of the Bank to pay dividends to the Bank's holding company.

The
Company's book value per share was $12.55 at September 30, 2004 compared with
$11.49 at December 31, 2003 and $11.25 at September 30, 2003.

During third quarter 2003, one hundred
thousand shares of $5.00 par value common stock were made available for
purchase to the Company through an arm's length transaction by a third party
for $29.00 per share. Based on the facts presented to management and the Board
of Directors, this transaction, which the Board of Directors approved, was
consummated on July 17, 2003.

The net
unrealized gain on available for sale securities (pre-tax) totaled $1.3 million
at September 30, 2004, up from a gain of $1.0 million at December 31, 2003. The
increasing trend of the unrealized position of available for sale securities at
September 30, 2004 over December 31, 2003 resulted from the recent
restructuring of the portfolio as well as the current investment security
market.  Beginning in late 2003, the securities available for sale portfolio was
restructured to assist in the stabilization of cash flows and the improvement
the effective yields in the portfolio. This shift has continued during the
first nine months of 2004.  In addition, beginning during the second quarter of
2004, the Company borrowed $30 million in FHLB long term borrowings and employed these funds in higher
yielding earning assets.

See Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Balance Sheet Review - Investment Securities Available for Salefor a
discussion regarding the factors impacting the fluctuation in unrealized gains
on such securities for the nine months ending September 30, 2004.

Regulatory
Capital RequirementsThe Company
and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies.  The guidelines are designed to make regulatory
capital requirements more sensitive to differences in risk profiles among banks
and bank holding companies, to account for off-balance sheet exposure, and to
minimize disincentives for holding liquid assets. Under these guidelines,
assets and certain off-balance sheet items are assigned to broad risk
categories, each with appropriate weights. The resulting capital ratios
represent capital as a percentage of total risk weighted assets and certain
off-balance sheet items. The Company and the Bank exceeded the well-capitalized
regulatory requirements at September 30, 2004. Failure to meet minimum capital requirements can
initiate certain mandatory actions by regulators that, if undertaken, could
have a material effect on the financial statements.  The Company's and the
Bank's capital amounts and classifications are subject to qualitative judgments
by the regulators about components, risk weightings, and other factors.

50




Quantitative
measures established by regulation to ensure capital adequacy require the
Company and the Bank to maintain minimum amounts and ratios of total and Tier 1
capital (as defined in the regulation) to risk-weighted assets (as defined in
the regulation) and to average assets.  At September 30, 2004, the Company and
the Bank were each categorized as "well capitalized" under the regulatory
framework for prompt corrective action.  To be categorized as "well
capitalized," the Company and the Bank must maintain minimum total risk-based,
Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following
table (dollars in thousands).  There have been no conditions or events of which
management is aware since September 30, 2004 that would change the Company's or
Bank's classification.





To be wellcapitalized underFor capital
   
   prompt correctiveActual
   
   adequacy purposes
   
   action provisionsamount
   
   ratio
   
   amount
   
   ratio
   
   amount
   
   ratioAt September 30, 2004Total capital to risk-weighted assetsPalmetto Bancshares, Inc.
   $
   81,448
   
   10.49%
   
   $
   62,109
   
   8.00%
   
   
   N/A
   
   N/ABank
   
   81,123
   
   10.45
   
   
   62,109
   
   8.00
   
   $
   77,636
   
   10.00%Tier 1 capital to risk-weighted assetsPalmetto Bancshares, Inc.
   $
   73,278
   
   9.44%
   
   $
   31,055
   
   4.00%
   
   
   N/A
   
   N/ABank
   
   72,953
   
   9.40
   
   
   31,055
   
   4.00
   
   $
   46,582
   
   6.00%Tier 1 capital to average assetsPalmetto Bancshares, Inc.
   $
   73,278
   
   7.75%
   
   $
   37,815
   
   4.00%
   
   
   N/A
   
   N/ABank
   
   72,953
   
   7.71
   
   
   37,825
   
   4.00
   
   $
   47,282
   
   5.00%


For further discussion of capital
regulatory requirements, see Supervision and Regulations contained in Item 1 of
the Company's Annual Report on Form 10-K for the year ended December 31, 2003.

ACCOUNTING AND REPORTING MATTERS

No recent
authoritative pronouncements that impact accounting, reporting, and disclosure
of financial information by us have occurred during the quarter ending
September 30, 2004, other than the items described below.

In November
2003, the Emerging Issues Task Force ("EITF") reached a consensus that certain quantitative
and qualitative disclosures should be required for debt and marketable equity
securities classified as available for sale or held to maturity under SFAS No.
115 and SFAS No. 124 that are impaired at the balance sheet date but for which
other-than-temporary impairment has not been recognized.  Accordingly EITF
issued EITF No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments."  This issue addresses the meaning of
other-than-temporary impairment and its application to investments classified
as either available for sale or held to maturity under SFAS No. 115 and
provides guidance determining the amount of impairment and additional
quantitative and qualitative disclosures. The guidance for determining the
amount of impairment was scheduled to be effective for periods ending after
June 15, 2004, but has been delayed indefinitely pending implementation
guidance by the FASB.    The disclosure provisions of EITF No. 03-1 were
effective for fiscal years ending after December 15, 2003.  Adopting the
disclosure provisions of EITF No. 03-1 did not have any impact on the Company's
financial position or results of operations.

51




In March
2004, the FASB issued an exposure draft on "Share-Based Payment".  The proposed
Statement addresses the accounting for transactions in which an enterprise
receives employee services in exchange for (a) equity instruments of the
enterprise or (b) liabilities that are based on the fair value of the
enterprise's equity instruments or that may be settled by the issuance of such
equity instruments.  This proposed Statement would eliminate the ability to
account for share-based compensation transactions using APB Opinion No. 25,
"Accounting for Stock Issued to Employees", and generally would require instead
that such transactions be accounted for using a fair-value-based method.  This
Statement, if approved, was scheduled to be effective for awards that are
granted, modified, or settled in fiscal years beginning after a) December 15,
2004 for public entities and nonpublic entities that used the fair-value-based
method of accounting under the original provisions of Statement 123 for
recognition or pro forma disclosure purposes and b) December 15, 2005 for all
other nonpublic entities.On October 16, 2004, the FASB delayed the
effective date of this proposal by six months and anticipates it will be
effective for by the third quarter of 2005. Retrospective application of this
Statement is not permitted.  The adoption of this Statement, if approved, could
have an impact on the Company's financial position or results of operations.

Other
accounting standards that have been issued or proposed by the FASB or other
standards-setting bodies that do not require adoption until a future date are
not expected to have a material impact on the consolidated financial statements
upon adoption.

52








Item 3. 
Quantitative and Qualitative Disclosures about Market Risk

See Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Market Risk Management - Asset-Liability Management and Interest Rate
Risk for quantitative
and qualitative disclosures about market risk.

Item 4. 
Controls and Procedures

Evaluation of Disclosure
Controls and Procedures

An evaluation of the Company's
disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule
15d-15(e) under the Securities Exchange Act of 1934) was carried out under the
supervision and with the participation of the Company's Chairman and Chief
Executive Officer and the Company's President and Chief Operating Officer
(Chief Accounting Officer) as of the end of the period covered by this
Quarterly Report (the "Evaluation Date"). The Company's Chairman and Chief
Executive Officer and the Company's President and Chief Operating Officer
(Chief Accounting Officer) concluded as of the Evaluation Date that disclosure
controls and procedures were effective in ensuring that the information
required to be disclosed by the Company in the reports it files or submits
under the Securities Exchange Act of 1934 is (i) accumulated and communicated
to management (including the Company's Chairman and Chief Executive Officer and
the Company's President and Chief Operating Officer (Chief Accounting Officer))
in a timely manner, and (ii) recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commission's
rules and forms.

Changes in Internal Controls

During the third quarter of 2004, the
Company did not make any change in its internal control over financial
reporting or other factors that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.

53








PART II.  OTHER INFORMATION

Item 1. 
Legal Proceedings

See Note 9
of the Notes To
Interim Consolidated Financial Statements for a discussion of legal proceedings.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3.  Defaults Upon Senior Securities

None

Item 4.  Submission of Matters to a Vote of Securities Holders

None

Item 5. 
Other Information

None

Item 6. 
Exhibits

31.1      L. Leon Patterson's
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2      Paul W. Stringer's
Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32         Certifications
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

54




SIGNATURES

Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned thereunto duly authorized.



PALMETTO BANCSHARES, INC.



By:

/s/      L. Leon
Patterson L. Leon Patterson
 Chairman and Chief Executive
Officer

/s/      Paul W. Stringer Paul W. Stringer
 President and Chief Operating
Officer
 (Chief Accounting Officer)
 
Date:   November 9, 2004

55